THE 

ARTHUR  YOUNG 

ACCOUNTING 

COLLECTION 


Graduate  School  of 
Business  Administration 

Library  of  the 

University  of  California 

Los  Angeles 


SOUTHERN   BRANCH 

UNIVERSITY  OF  CALIFORNIA 
LIBRARY 

LOS  ANGELES,  CALIF. 


n 
Graduate  S,-oi  o   U!  iness  Idmini.tratton 

7  of  California 
Los  ^^oles  24,  Calif orniet 


MATERIALS  FOR  THE  STUDY 
OF  BUSINESS 


PRINCIPLES  OF  ACCOUNTING 


THE  UNIVERSITY  OP  CHICAGO  PRESS 
CHICAGO,  ILLINOIS 


THE  CAMBRIDGE  UNIVERSITY  PRESS 

LONDON 

THE  MARUZEN-KABDSHIKI-KAISHA 

TOKYO,  OSAKA,  KYOTO,  FUKUOKA,  BENDAl 

THE  MISSION  BOOK  COMPANY 

SHANGHAI 


PRINCIPLES  OF  ACCOUNTING 


BY 

ALBERT  CLAIRE  HODGE 

AND 

JAMES  OSCAR  McKINSEY 


THE  UNIVERSITY  OF  CHICAGO  PRESS 
CHICAGO,  ILLINOIS 

WIT 


COPYRIGHT  1920  BY 
THE  UNIVERSITY  OF  CHICAGO 


All  Rights  Reserved 


Published  September  1920 
Second  Impression  October  1921 


Composed  and  Printed  By 

The  University  of  Chicago  Press 

Chicago.  Illinois.  U.S.A. 


Library 

HF 


Collegiate  training  for  business  management  is  now  so  widely 
attempted  that  the  time  has  arrived  when  experiments  should  be 
conducted  looking  toward  the  organization  of  the  business  curriculum 
into  a  coherent  whole.  Training  in  scattered  "business  subjects" 
was  defensible  enough  in  the  earlier  days  of  collegiate  business  training, 
but  such  a  method  cannot  be  permanent.  It  must  yield  to  a  more 
comprehensive  organization. 

There  can  be  no  doubt  that  many  experiments  will  be  conducted 

^'looking  toward  this  goal;  they  are,  indeed,  already  under  way.    This 

i  series,  "  Materials  for  the  Study  of  Business, "  marks  one  stage  in  such 

jjr'an  experiment  in  the  School  of  Commerce  and  Administration  of  the 

^  University  of  Chicago. 

,       It  is  appropriate  that  the  hypotheses  on  which  this  experiment  is 

jj  being  conducted  be  set  forth.     In  general  terms  the  reasoning  back 

^of  the  experiment  runs  as  follows:  The  business  manager  administers 

his  business  under  conditions  imposed  by  his  environment,  both 

_  physical  and  social.    The  student  should  accordingly  have  an  under- 

t  standing  of  the  physical  environment.    This  justifies  attention  to 

^  the  earth  sciences.    He  should  also  have  an  understanding  of  the 

^  social  environment  and  must  accordingly  give  attention  to  civics,  law, 
economics,  social  psychology,  and  other  branches  of  the  social  sciences. 
His  knowledge  of  environment  should  not  be  too  abstract  in  character. 
It  should  be  given  practical  content,  and  should  be  closely  related  to 
his  knowledge  of  the  internal  problems  of  management.  This  may  be 
accomplished  through  a  range  of  courses  dealing  with  business  manage- 
ment wherein  the  student  may  become  acquainted  with  such  matters 
as  the  measuring  aids  of  control,  the  communicating  aids  of  control, 
organization  policies  and  methods;  the  manager's  relation  to  pro- 
duction, to  labor,  to  finance,  to  technology,  to  risk-bearing,  to  the 
market,  to  social  control,  etc.  Business  is,  after  all,  a  pecuniarily 
organized  scheme  of  gratifying  human  wants,  and,  properly  under- 
stood, falls  little,  if  any,  short  of  being  .as  broad,  as  inclusive,  as  life 
itself  in  its  motives,  aspirations,  and  social  obligations.  It  falls 


viii  EDITOR'S  PREFACE 

little  short  of  being  as  broad  as  all  science  in  its  technique.  Training 
for  the  task  of  the  business  manager  must  have  breadth  and  depth 
comparable  with  those  of  the  task. 

Stating  the  matter  in  another  way,  the  modern  business  manager 
is  essentially  a  solver  of  business  problems — problems  of  business 
policy,  of  organization,  and  of  operation.  These  problems,  great  in 
number  and  broad  hi  scope,  divide  themselves  into  certain  type 
groups,  and  in  each  type  group  there  are  certain  types  of  obstacles 
to  be  overcome,  as  well  as  certain  aids,  or  materials  of  solution. 

If  these  problems  are  grouped  (i)  to  show  the  significance  of  the 
organizing  and  administrative,  or  control,  activities  of  the  modern 
responsible  manager,  and  (2)  to  indicate  appropriate  fields  of  train- 
ing, the  diagram  on  the  opposite  page  (which  disregards  much  over- 
lapping and  interacting)  results.  It  sets  forth  the  present  hypothesis 
of  the  School  of  Commerce  and  Administration  concerning  the  basic 
elements  of  the  business  curriculum. 

This  present  volume  hi  the  series  is  designed  to  acquaint  the 
student  with  the  functions  and  methods  of  accounting  as  an  instru- 
ment of  business  control. 

L.  C.  MARSHALL 


EDITOR'S  PREFACE 


IX 


BASIC  ELEMENTS  OF  THE  BUSINESS  CURRICULUM 


Of  problems  of  adjustment   to 
physical  environment 

a)  The  earth  sciences 

b)  The  manager's  relationship 
to    these 

Of  problems  of  technology 
a)  Physics  through  mechanics, 
basic,  and  other   sciences 
as  appropriate 

6)  The  manager's  administra- 
tion of  technology 
Of  problems  of  finance 

a)  The  financial  organization 
of  society 

b)  The    manager's    adminis- 
tration of  finance 

Of  problems  connected  with  the 
market 

a)  Market  functions  and  mar- 
ket structure 

b)  The  manager's  administra- 
tion of  marketing  (including 
purchasing  and  traffic) 

Of  problems  of  risk  and  risk- 
bearing 
a)  The  risk  aspects  of  modern 

industrial  society 
4)  The  manager's  administra- 
tion of  risk-bearing 
Of  problems  of  personnel 

a)  The  position  of  the  worker 
in  modern  industrial  society 
6)  The  manager's  administra- 
tion of  personnel 
Of  problems  of  adjustment  to 
social  environment 

a)  The  historical  background 

b)  The  socio-economic  insti- 
tutional life 

c)  Business  law  and  govern- 
ment 


CONTROL 

1.  Communicating  aids  of  control, 

for  example 

a)  English 

b)  Foreign  language 

2.  Measuring  aids  of  control,  for 

example 

a)  Mathematics 

b)  Statistics  and  accounting 

3.  Standards  and  practices  of  con- 

trol 

a)  Psychology 
/>)  Organization    policies    and 

methods 


AUTHORS'  PREFACE 

This  text  is  designed  to  accomplish  three  things: 

1.  To  give  the  prospective  business  manager  a  fairly  definite  idea 
of  the  type  of  service  which  can  and  should  be  provided  by  accounting 
as  a  measuring  aid  of  business  control. 

2.  To  give  him  a  working  knowledge  of  the  fundamental  prin- 
ciples  underlying   the   gathering,   analysis,   and   interpretation   of 
accounting  data. 

3.  To  give  him  at  least  an  elementary  knowledge  of  the  technique 
employed  in  gathering  accounting  .data,  and  in  preparing  the  more 
generally  used  accounting  reports. 

If  these  three  objectives  are  successfully  attained,  the  text  should 
not  only  be  useful  to  the  student  in  a  collegiate  school  of  business  but 
should  serve  equally  well  as  the  basis  of  an  introductory  course  in 
accounting  for  students  from  other  departments  of  a  university. 

It  should  be  understood  that  this  text  is  not  intended  to  furnish 
material  for  a  full  year's  work  in  accounting.  It  is  intended  to  give 
a  survey  of  the  accounting  process,  the  presentation  of  which  will 
extend  over  approximately  one  semester  or  quarter.  A  second 
volume,  now  in  preparation,  will  show  in  some  detail  the  application 
of  the  principles  developed  in  this  "survey"  course  to  problems  of 
internal  management  and  budgetary  control. 

This  text  proceeds  on  the  assumption  that  the  primary  function 
of  accounting  in  modern  industrial  society  is  that  of  providing  such 
statistical  information  for  the  various  parties  who  exercise  control 
over  any  business  enterprise  as  will  guide  them  in  the  exercise  of  this 
control.  This  idea  is  developed  rather  fully  in  the  introductory 
chapter.  Starting  with  this  assumption,  the  student  is  led  to  see  the 
need  for  the  accounting  reports,  and  is  given  an  idea  of  the  nature  and 
form  of  the  more  widely  used  of  these  reports.  The  construction 
of  the  accounts,  and  the  forms  of  accounting  records  used  in  recording 
and  classifying  the  information  which  affects  the  accounts,  are  then 
considered  as  means  of  making  available  such  items  of  information 
as  will  be  required  in  the  preparation  of  the  accounting  reports. 
The  first  sixteen  chapters  are  intended  to  give  the  student  an  under- 
standing of  the  nature  of  the  ''accounting  process"  as  a  whole.  This 
first  part  of  the  book  starts  with  a  discussion  of  the  reports  and 


xii  .     AUTHORS'  PREFACE 

develops  the  idea  of  the  accounting  process  by  proceeding  from  the 
reports  to  the  ledger  accounts,  from  the  accounts  to  the  books  of 
original  entry,  from  these  forms  of  record  to  the  vouchers,  and 
thence  to  the  business  transaction.  The  second  part  begins  with 
the  transactions  and  the  vouchers,  proceeds  to  the  books  of  original 
entry,  thence  to  the  accounts,  with  careful  attention  to  their  classi- 
fication, construction,  and  interpretation,  and  finally  to  the  use  of 
the  accounts  in  preparing  the  accounting  reports.  Thus  the  student 
is  taken  through  the  accounting  process  twice.  The  first  time  he 
starts  by  considering  what  it  is  that  the  accountant  is  trying  to 
accomplish,  and  then  develops  the  means  by  which  this  is  to  be 
accomplished.  The  second  time  he  follows  the  process  through  in 
the  order  in  which  it  actually  occurs,  giving  considerably  more 
attention  than  before  to  matters  of  procedure,  form,  and  technique. 

Since  college  students  are  presumably  not  studying  accounting 
with  the  aim  of  becoming  bookkeeping  clerks,  an  effort  has  been 
made  to  reduce  the  amount  of  routine  work  demanded  in  the  labora- 
tory exercises  to  the  minimum.  At  the  same  time,  it  has  been  the 
ami  of  the  authors  to  make  sure  that  every  important  principle 
developed  in  the  text  has  been  amply  illustrated  by  means  of 
laboratory  exercises. 

The  questions  at  the  end  of  each  chapter  are  designed  to  aid  the 
student  hi  his  study  of  the  chapter,  and  also  to  be  suggestive  to  the 
instructor  in  his  guidance  of  the  class  discussion.  The  "References 
for  Further  Study"  are  intended  for  both  instructor  and  students. 
It  may  be  suggested,  however,  that  in  the  earlier  stages  of  his  study 
of  accounting  the  student  is  in  some  danger  of  being  confused  by  an 
attempt  to  consider  the  points  of  view  of  too  many  writers. 

The  authors  desire  to  make  acknowledgment  of  the  valuable 
assistance  rendered  by  Mr.  Robert  Thome,  an  undergraduate  in  the 
School  of  Commerce  and  Administration,  who  prepared  the  charts 
used  hi  chapter  xxxi.  They  desire  also  to  acknowledge  their  indebted- 
ness to  Dean  Leon  Carroll  Marshall  of  the  School  of  Commerce  and 
Administration,  and  to  Mr.  George  E.  Frazer,  C.P.A.,  each  of  whom 
has  exercised  an  important  influence  on  the  point  of  view  and  the 
method  of  approach  adopted  in  the  preparation  of  the  text. 

A.  C.  HODGE 
J.  O.  McKiNSEY 

SCHOOL  OF  COMMERCE  AND  ADMINISTRATION 

UNIVERSITY  OF  CHICAGO 

October  i,  1920 


TABLE  OF  CONTENTS 

PAGX 

CHAPTER  I.    THE  MEANING  AND  FUNCTION  OF  ACCOUNTING 

Students  of  Accounting  Are  of  Different  Classes    ....  i 

Fundamentals  of  Accounting  Same  for  All  Classes.               .       .  i 

Accounting  an  Instrument  of  Business  Control      ....  2 

Reports  May  Be  of  Various  Types 3 

Reports  Useful  to  Various  Interested  Parties 3 

Increased  Size  Has  Meant  Greater  Complexity  in  Business  Organi- 
zation        4 

Nature  of  Reports  Affected  by  Functional  Organization      .       .  6 

Reports  Required  by  Owners  and  Prospective  Investors      .       .  7 

Creditors  Require  Reports 8 

The  Public  an  Interested  Party 8 

Summary  of  Parties  Requiring  Reports 9 

Accountant's  Task  to  Gather  Data  and  Prepare  Reports       .       .  10 

CHAPTER  II.    THE  RELATIONSHIP  OF  ACCOUNTING  TO  PROPRIETOR- 
SHIP 

The  Basis  of  Business  Management 13 

Business  Investment  Implies  Existence  of  Assets  and  Liabilities  14 

Proprietorship 15 

Object  of  Business  Operations  to  Increase  Proprietorship    .       .  16 

Proprietorship  the  Excess  of  Assets  over  Liabilities       ...  17 

Proprietorship  May  Assume  Various  Forms 18 

Single  Proprietor  Needs  Reports  for  Control 18 

Partnership  Form  Involves  Additional  Considerations  ...  19 

Corporation  Typically  a  Modern  Form 20 

Summary 21 

CHAPTER  III.    THE  BALANCE  SHEET 

The  Function  of  the  Balance  Sheet 25 

Form  of  the  Balance  Sheet 26 

Debts  Owed  by  Customers 27 

Merchandise  on  Hand 28 

Debts  Owed  Merchandise  Creditors 28 

The  Balance  Sheet  with  Accounting  Terminology 29 

Methods  of  Determining  the  Value  of  Certain  Assets   ...  30 

Heading  or  Title  of  the  Balance  Sheet 31 

Subtitles  of  the  Balance  Sheet 31 

Illustration  of  the  Standard  Form  of  Balance  Sheet      ...  33 


xiv  TABLE  OF  CONTENTS 

PAGE 

CHAPTER  IV.    THE  STATEMENT  OF  PROFIT  AND  Loss 

Statement  of  Profit  and  Loss  Needed  to  Supplement  Balance  Sheet  39 

Form  of  Statement  of  Profit  and  Loss      .       .       .       .    '  .       .  41 

Sales .       .  43 

Cost  of  Goods  Sold 43 

Gross  Profit  on  Sales 44 

Classification  of  Expenses 44 

Operating  and  Non-operating  Expenses 45 

Heading  or  Title  of  Statement  of  Profit  and  Loss  ....  46 
Illustration  of  the  Conventional  Form  of  the  Statement  of  Profit 

and  Loss 47 

Balance  Sheet  and  Statement  of  Profit  and  Loss  Taken  as  Types  of 

Reports      .  *    .  '    .       .48 

CHAPTER  V.    THE  ACCOUNT  AS  A  MEANS  OF  CLASSIFYING  INFOR- 
MATION 

A  Means  of  Classifying  Business  Data  Needed      ....  53 

The  Account  a  Means  of  Classification 54 

The  Form  of  the  Account 56 

The  Balance  of  the  Account 57 

Interpretation  of  the  Account  Balance 58 

The  Ledger  and  Its  Contents 60 

Use  of  the  Terms  Debit  and  Credit  in  Relation  to  the  Account  .  64 

Accounts  Affected  by  Business  Transactions 61 

Determination  of  Debits  and  Credits  to  Accounts         ...  63 

Equality  of  Debits  and  Credits  to  the  Accounts    ....  63 

CHAPTER  VI.    THE  CONSTRUCTION  AND  INTERPRETATION  OF  PAR- 
TICULAR ACCOUNTS 

Certain  Facts  to  Be  Considered  in  Interpreting  Accounts    .       .  67 

Cash  Account 67 

Accounts  with  Debtors ,68 

Notes  Receivable 68 

Accounts  Receivable 69 

Accounts  with  Creditors 70 

Notes  Payable 70 

Accounts  Payable 71 

Accounts  with  Fixed  Assets 71 

Office  Furniture  or  Equipment 73 

Reserve  for  Depreciation  of  Office  Furniture 74 

Delivery  Equipment 75 

Reserve  for  Depreciation  of  Delivery  Equipment  ....  75 

Accounts  with  Proprietorship 76 


TABLE  OF  CONTENTS  XV 

PAGE 

CHAPTER  VII.    THE  CONSTRUCTION  AND  INTERPRETATION  OF  AC- 
COUNTS 

Accounts  with  Merchandise 81 

The  Purchases  Account 81 

The  Sales  Account 82 

The  Inventory  Account       . 82 

Accounts  with  Operating  Expenses 83 

Buying  Expenses 83 

Selling  Expenses 84 

Accounts  with  Delivery  Expense  and  Drayage  Expense       .       .  84 

Administrative  Expenses 86 

Arrangement  of  Accounts  in  the  Ledgers 86 

Summary 87 

CHAPTER  VIII.    THE  TRIAL  BALANCE 

Purpose  of  the  Trial  Balance 92 

Method  of  Taking  a  Trial  Balance 92 

Illustration  of  the  Trial  Balance 93 

The  Trial  Balance  as  a  Report 97 

CHAPTER  IX.    THE  ADJUSTING  ENTRIES 

Need  of  Adjusting  Entries 101 

Merchandise  Inventory 102 

Illustration  of  the  Inventory  Account  and  Adjustments       .       .  103 

Office  Furniture  and  Delivery  Equipment       .       .       .       .       .  105 

Methods  of  Showing  Expenses  in  Accounts 106 

CHAPTER  X.    THE  CLOSING  ENTRIES 

Purpose  of  the  Closing  Entries 109 

Gross  Profit  on  Sales 109 

Profit  and  Loss  Account no 

Net  Operating  Profit .       .       .in 

The  Ledger  after  Closing 113 

Balancing  and  Closing  the  Accounts        .       .       .       .       .       .114 

The  Ruling  of  Current  Accounts  with  Persons  and  of  Note 
Accounts .115 

CHAPTER  XI.    THE  SOURCE  OF  THE  LEDGER  ENTRIES 

Need  for  a  Record  Other  than  the  Ledger 118 

The  Nature  of  Books  of  Original  Entry 120 

The  Journal .121 

Illustration  of  the  Journal 122 

Posting 126 

Illustration  of  Posting 1 26 

Summary 129 


svi  TABLE  OF  CONTENTS 

PAGE 

CHAPTER  XII.    SOME  SPECIAL  FORMS  OF  THE  JOURNAL 

Need  for  Special  Books  of  Record — Advantages  of  Their  Use  132 

The  Purchases  Journal        .    , 135 

The  Purchases  Journal  Illustrated    .....'..  136 

Posting  from  the  Purchases  Journal 137 

The  Sales  Journal 138 

Illustration  of  Sales  Journal 139 

Posting  from  the  Sales  Journal 140 

The  Cash  Journals 140 

Form  of  the  Cash  Book 141 

Nature  of  the  Cash  Book 142 

Posting  the  Cash  Book 143 

Summary 143 

CHAPTER  XIII.    THE  USE  OF  THE  GENERAL  JOURNAL 

Effect  of  Special  Journals  on  the  General  Journal  ....  147 

Opening  Entries 147 

Current  Entries 149 

Adjusting  Entries 152 

The  Closing  Entries 153 

CHAPTER  XIV.    BUSINESS  VOUCHERS  AND  FORMS 

Purpose  of  the  Voucher 159 

Classification  of  Vouchers  and  Forms 160 

The  Merchandise  Invoice 160 

Form  of  the  Merchandise  Invoice 162 

Negotiable  Instruments 162 

Requisites  of  Negotiable  Instruments      .       .       .       .     • .       .165 

Kinds  of  Negotiable  Instruments .       .166 

The  Draft 166 

The  Cashier's  Check 169 

Express  and  Postal  Money  Orders 170 

CHAPTER  XV.    BUSINESS  VOUCHERS  AND  FORMS  (Concluded) 

Indorsement  of  Negotiable  Instruments 174 

Miscellaneous  Business  Forms 176 

The  Statement  of  Account 177 

The  Receipt 178 

The  Bill  of  Lading 179 

Forms  Used  in  Transactions  with  the  Bank    .       .       .       .       .180 

The  Deposit  Ticket 181 

The  Signature  Card     .                             182 

The  Pass  Book 182 

The  Bank  Statement 182 

The  Check  184 


TABLE  OF  CONTENTS  xvii 

PAGE 

CHAPTER  XVI.    THE  ACCOUNTING  PROCESS 

Purpose  of  the  Chapter .       .186 

Accounting  Reports 186 

The  Accounts .188 

The  Books  of  Original  Entry 188 

Business  Vouchers  and  Forms    .       . 189 

The  Accounting  Process 190 

Importance  of  the  Accounting  Process 191 

CHAPTER  XVII.    BUSINESS  PRACTICE  AND  PROCEDURE — PURCHASES 
AND  SALES 

Purpose  of  the  Chapter 193 

Methods  of  Handling  Purchases        .       .       .       .       .       .       .193 

The  Purchase  Requisition 194 

The  Purchase  Order *       ....  195 

The  Purchase  Invoice 196 

Methods  of  Handling  Sales — the  Sales  Order 197 

The  Sales  Invoice 199 

Shipping  or  Delivery  of  Merchandise 199 

CHAPTER  XVIII.     BUSINESS    PRACTICE    AND    PROCEDURE — CASH 
AND  NOTES 

Cash  Receipts 202 

Cash  Disbursements 203 

Petty  Cash  Funds 204 

The  Imprest  System  for  Petty  Cash 204 

Method  of  Handling  Notes  Receivable  and  Payable     .       .       .206 

Use  of  the  Trade  Acceptance 207 

Accounting  for  Trade  Acceptances 210 

CHAPTER  XIX.    BOOKS  OF  ORIGINAL  ENTRY — SALES  AND  PURCHASES 
RECORDS 

Purpose  of  Books  of  Original  Entry 212 

Subdivisions  of  the  Journal 212 

Use  of  Special  Columns  in  Books  of  Original  Entry      .       .       .213 

The  Recording  of  Sales 214 

Cash  Sales 215 

Analysis  of  Sales  by  Departments 216 

Recording  Retail  Sales 217 

Sales  Deductions 217 

Sales  Returns  and  Allowances  Journal 218 

Recording  Purchases 219 

Departmental  Analysis  in  the  Purchases  Journal   .       .       .       .220 

Purchases  Other  than  Merchandise • .       .  220 

Purchase  Deductions   .  221 


xviii  TABLE  OF  CONTENTS 

PAGE 

CHAPTER  XX.  JBooxs  OF  ORIGINAL  ENTRY — THE  CASH  JOURNAL 

The  Cash  Book 223 

Cash  Receipts — Analysis 223 

Cash  Receipts — Credits 224 

Illustration  of  Cash  Receipts  Journal 225 

Analysis  of  Cash  Disbursements — Credits   • 227 

Analysis  of  Cash  Disbursements — Debits 227 

Illustration  of  the  Cash  Disbursements  Journal     .       .       .       .228 

CHAPTER  XXI.    CONTROLLING  ACCOUNTS 

Some  Uses  of  Special  Columns 237 

The  Controlling  Account 237 

The  Use  of  the  Controlling  Account  Illustrated     .       .       .       .242 
Summary *    .  250 

CHAPTER  XXII.     THE   CONSTRUCTION   AND    INTERPRETATION   OF  ' 
ACCOUNTS — ASSETS 

Cash  Account 253 

Accounts  Receivable 254 

Reserve  for  Bad  Debts 255 

Notes  Receivable 256 

Notes  Receivable  Discounted .257 

Notes  Receivable  Dishonored 259 

Accounts  with  Fixed  Assets 259 

Charges  to  Capital  versus  Charges  to  Revenue      ....     260 

CHAPTER  XXIII.    CONSTRUCTION  AN&  INTERPRETATION  OF  ACCOUNTS — 
LIABILITIES 

Purpose  of  the  Chapter 266 

Current  Liabilities 266 

Accounts  Payable .  266 

Notes  Payable 267 

Fixed  Liabilities 268 

Mortgages  Payable t 269 

Bonds  Payable 269 

Long-Term  Notes 271 

CHAPTER  XXIV.    CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS — 
PROPRIETORSHIP  ACCOUNTS 

Purpose  of  the  Chapter 273 

Proprietorship  Accounts  for  the  Single  Proprietor  .       .       .       .273 
The  Proprietor's  Personal  Account   .       .       .       .       .       .       .274 

Proprietorship  Accounts  in  the  Partnership 275 

The  Partner's  Drawing  Account 275 


TABLE  OF  CONTENTS  xix 

PAGE 

Proprietorship  Accounts  in  the  Corporation 277 

Capital  Stock 277 

Discount  on  Stock 278 

Surp'us .  279 

Proprietorship  Reserves 280 

CHAPTER  XXV.    CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS — 
INCOME  ACCOUNTS 

Kinds  of  Income  Accounts  .       . 288 

Accounts  with  Operating  Income 288 

Sales  Account 288 

Deductions  from  Sales 290 

Non-operating  Income  Accounts 291 

Interest  on  Notes  Receivable     .       .       .       .  .       .       .291 

Cash  Discount  on  Purchases 292 

CHAPTER  XXVI.    CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS — 
EXPENSE  ACCOUNTS 

Kinds  of  Expense  Accounts 295 

Operating  Expense  Accounts 295 

Cost  of  Goods  Sold  Accounts 296 

Purchases  Accounts 296 

Accounts  with  Purchases  Deductions 297 

Other  Cost  of  Goods  Sold  Accounts 298 

Other  Operating  Expense  Accounts 299 

Accounts  with  Estimated  Operating  Expenses       ....  300 

Accounts  with  Other  Deductions  from  Income       ....  301 

Interest  on  Notes  Payable 302 

Cash  Discount  on  Sales 302 

CHAPTER  XXVII.    ACCRUALS  AND  DEFERRED  ITEMS 

Types  of  Items  to  Be  Considered 305 

Accrued  Income 305 

Accrued  Expenses 308 

Deferred  Charges  to  Expense 310 

Deferred  Credits  to  Income 313 

CHAPTER  XXVIII.    THE  ADJUSTING  AND  CLOSING  ENTRIES 

Need  for  Such  Entries 318 

Th   Working  Sheet 319 

Illustration  of  the  Working  Sheet 319 

The  Statement  of  Profit  and  Loss 322 

The  Balance  Sheet 325 

The  Closing  Entries 326 

The  Post-closing  Entries 328 

The  Post -closing  Trial  Balance 329 


EC  TABLE  OF  CONTENTS 

PAGE 

CHAPTER  XXIX.    THE  CLASSIFICATION  OF  ACCOUNTS 

The  Purpose  Served  by  the  Accounts       ......  334 

The  Fundamental  Classification  of  Accounts 335 

The  Property  Accounts       .       . 336 

Illustration  of  the  Property  Accounts 337 

The  Proprietorship  Accounts      .       •. 338 

The  Revenue  Accounts 340 

Illustration  of  the  Revenue  Accounts 341 

Numbering  of  Accounts 343 

Illustration  of  the  Numbering  of  Accounts 344 

Lack  of  Uniformity  hi  Classification  and  Numbering  of  Accounts  346 

CHAPTER  XXX.    FINANCIAL  REPORTS 

Nature  and  Purpose  of  Financial  Reports 349 

The  Conventional  Financial  Reports 349 

Exhibits 350 

Schedules       .       .   • 351 

Analytical  Statements .       .352 

_, —  The  Comparative  Balance  Sheet 353 

The  Analysis  of  the  Surplus  Account 353 

The  Comparative  Statement  of  Profit  and  Loss  ....  358 
The  Statement  of  Receipts  and  Disbursements  .  .  .  .361 

CHAPTER  XXXI.    THE  GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT- 
ING FACTS 

Diversified  Reports  Required  by  Management       ....     364 

The  Use  of  the  Statistical  Method 364 

Illustration  of  the  Statistical  Method 366 

The  Graphic  Method  Illustrated 367 

Comparison  of  Gross  Sales  with  Net  Sales  .  .  .  .  .370 
Comparison  of  Gross  Sales  and  Cost  of  Goods  Sold  .  .  .37° 
Comparison  of  Gross  Sales  and  Advertising  Expense  .  .  .  372 
Comparison  of  Gross  Sales  and  Operating  Expenses  .  .  .373 

Comparison  of  Gross  Sales  and  Net  Profit 374 

Other  Methods  of  Graphical  Presentation 374 

Advantages  of  the  Graphic  Method 376 

Limitations  of  the  Graphic  Method 376 

Summary 377 

APPENDIX 379 

INDEX 391 


LIST  OF  ILLUSTRATIONS 

PAGE 

1.  BALANCE  SHEET,  REPORT  FORM       .       .       .       .      .      .      .33 

2.  BALANCE  SHEET,  ACCOUNT  FORM 34 

3.  STATEMENT  OF  PROFIT  AND  Loss 47 

4.  THE  ACCOUNT 56 

5.  THE  LEDGER 93 

6.  THE  TRIAL  BALANCE 97 

7.  RULING  OF  THE  ACCOUNT 115 

8.  RULING  OF  CURRENT  ACCOUNTS 116 

9.  THE  JOURNAL .  124 

10.  LEDGER 127 

11.  PURCHASES  JOURNAL 136 

12.  SALES  JOURNAL 139 

13.  DEBIT  SIDE  OF  CASH  BOOK 141 

14.  CREDIT  SIDE  OF  CASH  BOOK 142 

15.  ADJUSTING  ENTRIES 153 

16.  CLOSING  ENTRIES 154 

17.  MERCHANDISE  INVOICE 162 

18.  SALES  TICKET 163 

19.  CHECK 164 

20.  NOTE 164 

21.  BANK  DRAFT        .              167 

22.  COMMERCIAL  DRAFT .  167 

23.  COMMERCIAL  DRAFT 168 

24.  CASHIER'S  CHECK 170 

25.  EXPRESS  MONEY  ORDER 170 

26.  STATEMENT  OF  ACCOUNT 178 

27.  DEPOSIT  TICKET 181 

28.  BANK  STATEMENT 183 

29.  PURCHASE  REQUISITION 194 

30.  PURCHASE  ORDER 196 

31.  SALES  ORDER 198 

32.  PETTY  CASH  JOURNAL 204 

33.  PETTY  CASH  BOOK .205 

34.  NOTES  RECEIVABLE  REGISTER 207 

35.  NOTES  PAYABLE  REGISTER 207 

36.  TRADE  ACCEPTANCE 208 

37.  DEBIT  SIDE  OF  CASH  BOOK 214 

xxi 


xxii  LIST  OF  ILLUSTRATIONS 

PAGE 

38.  SALES  JOURNAL           .     - 215 

39.  SALES  JOURNAL 216 

40.  SALES  JOURNAL 216 

41.  SALES  JOURNAL 217 

42.  SALES  RETURNS  AND  ALLOWANCES  JOURNAL         .       .       .       .218 

43.  SALES  RETURNS  AND  ALLOWANCES  JOURNAL         .       .       .       .219 

44.  PURCHASES  JOURNAL 219 

45.  PURCHASES  JOURNAL 220 

46.  PURCHASE  RETURNS  AND  ALLOWANCES  JOURNAL  .       .       .       .221 

47.  DEBIT  SIDE  OF  CASH  BOOK 226 

48.  CREDIT  SIDE  OF  CASH  BOOK 229 

49.  DEBIT  SIDE  OF  CASH  BOOK 239 

50.  CREDIT  SIDE  OF  CASH  BOOK .241 

51.  PURCHASES  JOURNAL 243 

52.  SALES  JOURNAL 243 

53.  CASH  BOOK          244 

54.  JOURNAL 246 

55.  LEDGER,  WITH  CONTROLLING  ACCOUNTS 246 

56.  INSURANCE  POLICY  RECORD 311 

57.  NOTES  DISCOUNTED  RECORD 314 

58.  ADJUSTING  ENTREES 321 

59.  WORKING  SHEET 323 

60.  STATEMENT  OF  PROFIT  AND  Loss 324 

61.  BALANCE  SHEET '. 325 

62.  CLOSING  ENTRIES 326 

63.  POST-CLOSING  ENTRIES 329 

64.  POST-CLOSING  TRIAL  BALANCE 330 

65.  NUMBERING  OF  ACCOUNTS 344 

66.  SCHEDULE  OF  CASH  BALANCE 351 

67.  ANALYSIS  OF  BUYING  EXPENSE 352 

68.  COMPARATIVE  BALANCE  SHEET         . 354 

69.  ANALYSIS  OF  SURPLUS  ACCOUNT 356 

70.  COMPARATIVE  STATEMENT  OF  PROFIT  AND  Loss,  WITH  PER- 

CENTAGES   359 

71.  STATEMENT  OF  RECEIPTS  AND  DISBURSEMENTS     .       .       .       .361 

72.  /  GRAPHIC  CHART  SHOWING  COMPARISON  OF  SALES  AND  ADVER- 

TISING EXPENSE 366 

73.  TABLE  SHOWING  MONTHLY  RATIOS  OF  GROSS  SALES  TO  ADVER- 

TISING EXPENSE 367 

74.  TABLE   SHOWING   SALES,    OPERATING   EXPENSES,   AND   NET 

OPERATING  PROFIT  FOR  A  YEAR,  ANALYZED  BY  MONTHS         .  368 


LIST  OF  ILLUSTRATIONS  xxiii 

PAGE 

75.  TABLE  SHOWING  COMPARISON  BY  MEANS  OF  PERCENTAGES       .    369 

76.  GRAPHIC  CHART  SHOWING  GROSS  SALES 369 

77.  GRAPHIC  CHART  SHOWING  COMPARISON  OF  GROSS  SALES  AND 

NET  SALES,  BY  MONTHS 371 

78.  GRAPHIC  CHART  SHOWING  COMPARISON  OF  GROSS  SALES  AND 

COST  OF  GOODS  SOLD,  BY  MONTHS 371 

79.  GRAPHIC  CHART  SHOWING  COMPARISON  OF  GROSS  SALES  AND 

ADVERTISING  EXPENSE,  BY  MONTHS 372 

So.    GRAPHIC  CHART  SHOWING  COMPARISON  OF  GROSS  SALES  AND 

OPERATING  EXPENSE,  BY  MONTHS 373 

81.  GRAPHIC  CHART  SHOWING  COMPARISON  OF  GROSS  SALES  AND 

NET  OPERATING  PROFIT,  BY  MONTHS 374 

82.  GRAPHIC  CHART  SHOWING  COMPARISON  OF  YEAR'S  SALES  WITH 

SALES  OF  PRECEDING  YEAR 375 

83.  GRAPHIC  CHART  SHOWING  COMPARISON  OF  SALES,  OPERATING 

EXPENSES,  AND  PROFITS,  FOR  EACH  OF  THREE  MONTHS         .     375 


CHAPTER  I 

THE  MEANING  AND  FUNCTION  OF  ACCOUNTING 

Students  of  accounting  are  of  different  classes.  In  taking  up  the 
study  of  accounting  it  should  be  recognized  at  the  outset  that  there 
is  more  than  one  field  in  which  the  student  may  later  desire  to  use  his 
knowledge  of  the  subject,  and  that  to  make  successful  use  of  a  knowl- 
edge of  accounting  in  any  one  of  these  fields  requires  a  training  of  a 
more  or  less  specialized  nature.  The  college  and  university  students 
who  present  themselves  for  training  in  accounting  may  be  divided 
into  three  rather  broad  groups,  which  may  be  defined  as  follows: 

1.  Those  who  study  accounting  with  the  aim  of  understanding  its 
use  as  a  means  of  social  control  over  business  activities.    This  group 
consists  for  the  most  part  of  students  of  economics,  whose  special 
interest  is  in  the  relation  of  government  to  business.     It  is  probably 
the  smallest  of  the  three  groups. 

2.  Those  who  expect  eventually  to  qualify  as  certified  public 
accountants  and  to  follow  the  profession  of  public  accounting,  in 
which  they  will  be  called  upon  to  deal  with  a  wide  range  of  accounting 
problems.    This  is  typically  a  larger  group  than  the  first  one. 

3.  Those  who  expect  to  become  business  executives  of  one  kind 
or  another,  or  to  furnish  specialized  accounting  service  to  the  manage- 
ment of  a  particular  business  enterprise  as  a  member  of  the  organiza- 
tion rather  than  as  a  public  accountant.    This  is  probably  much  the 
largest  of  the  three  groups. 

Fundamentals  of  accounting  same  for  all  classes.  It  is  for  the  third 
of  these  groups  that  this  introductory  text  in  accounting  is  primarily 
designed.  The  primary  object  of  schools  of  commerce  in  universities 
and  colleges  is  to  train  men  and  women  who  will  become  business 
managers.  It  seems  desirable  that  such  students  should  be  given  a 
survey  of  the  general  field  of  accounting.  They  should  be  made  famil- 
iar with  the  nature  of  the  accounting  process  in  general  and  with  the 
broad  underlying  principles  which  are  generally  recognized  as  sound 
by  practicing  accountants  and  by  writers  on  the  subject.  It  will  be 


2  PRINCIPLES  OF  ACCOUNTING 

found,  however,  that  a  beginning  course  in  accounting  which  furnishes 
the  student  with  a  satisfactory  foundation  for  the  continuation  of  his 
studies  in  any  one  special  field  of  accounting  will  serve  equally  well 
as  the  basis  for  specialization  hi  any  of  the  other  fields  of  accounting. 
If  this  text  is  successful  in  furnishing  the  business  manager  or  mana- 
gerial accountant  with  a  proper  approach  to  the  subject,  it  should 
render  an  equally  great  service  to  the  student  who  will  eventually 
decide  to  offer  his  services  to  business  owners  and  managers  as  a  public 
accountant  or  auditor,  or  as  a  specialist  in  any  line  of  accounting. 

Accounting  an  instrument  of  business  control.  In  the  study  of 
accounting,  one  should  not  expect  to  meet  with  any  new  and  exclusive 
subject-matter.  As  in  other  courses  in  the  field  of  business  training, 
the  scope  of  this  course  must  be  organized  industrial  society  as  a 
whole,  with  all  of  its  institutions.  The  prospective  business  man  and 
the  instructor  who  tries  to  help  train  him  are  interested  in  this  indus- 
trial society  primarily  on  account  of  the  manner  in  which  its  organiza- 
tion affects  the  nature  of  the  problems  which  the  business  manager 
must  meet.  In  order  to  deal  successfully  with  his  particular  prob- 
lems, the  manager  must  have  prepared  for  his  use  certain  data  in  the 
form  of  reports,  which  will  furnish  him  with  information  upon  which 
to  base  his  judgments.  It  is  the  function  of  accounting  to  prepare 
such  reports  and  to  provide  the  information  which  makes  their 
preparation  possible. 

It  is,  then,  with  the  use  of  reports  as  a  means  of  business  control 
that  the  student  will  be  chiefly  concerned  in  the  general  survey  of  the 
accounting  field  which  he  is  now  beginning.  Under  the  old  ideas  of 
nomenclature,  such  a  study  probably  would  not  be  termed  accounting 
in  preference  to  statistics,  but  that  is  not  a  point  which  need  cause  the 
student  any  particular  concern.  Statistics  is  the  technique  of  gather- 
ing, interpreting,  and  presenting  in  intelligible  form  information  which 
is  capable  of  being  expressed  numerically.  The  term  is  quite  inclu- 
sive and,  strictly  speaking,  accounting  is  merely  a  single  phase  of  the 
employment  of  the  statistical  method.  The  attempts  at  classification, 
subdivision,  and  pigeonholing  which  have  been  made  hi  the  curricula 
as  regards  the  field  of  statistics  have  served  to  obscure  its  relations  to 
the  uses  to  which  it  may  be  put  rather  than  to  clarify  them.  If  it  is 
desirable,  as  it  probably  is,  to  distinguish  accounting  from  the  general 
field  of  statistics,  the  demarcation  is  to  be  found  partly  in  the  nature 


THE  MEANING  AND  FUNCTION  OF  ACCOUNTING  3 

of  the  information  dealt  with,  namely,  the  records  of  the  particular 
business  enterprise,  and  partly  in  the  method  employed  in  classifying 
that  information,  namely,  the  account,  in  the  technical  sense.  It  will 
appear,  however,  as  the  student  proceeds  in  his  investigations  in  the 
subject,  that  the  reports  prepared  for  the  use  of  the  various  parties 
interested  in  the  business  are  not  all  made  up  from  information  fur- 
nished by  the  accounts,  so  called,  but  in  many  cases  are  drawn  from 
other  kinds  of  records  where  the  method  of  compiling  the  information 
is  not  peculiar  to  the  field  of  accounting  but  is  such  as  is  employed  in 
other  kinds  of  statistics.  For  purposes  of  this  text,  then,  it  is  not  neces- 
sary or  desirable  that  the  student  should  attempt  to  narrow  his  con- 
cept of  the  field  of  accounting  beyond  that  of  the  use  of  reports  as  an. 
aid  to  the  conduct  of  bus"iness,and  incidentally  an  aid  to  the  control  and 
regulation  by  society  of  certain  phases  of  private  business  enterprise. 

Reports  may  be  of  various  types.  It  may  not  be  safe  to  proceed 
on  the  assumption  that  the  student  is  clear  as  to  the  meaning  of  the 
word  "report"  as  here  employed.  As  a  matter  of  fact,  it  is  used 
in  no  peculiar  sense,  except  that  a  written  report  is  contemplated 
rather  than  'an  oral  one.  By  a  report,  as  used  in  connection  with 
business  management,  is  meant  merely  a  statement  of  certain  facts 
regarding  the  business,  or  regarding  plans  contemplated  hi  the  con- 
duct of  the  business.  This  statement  shows  such  analysis  of  the 
information  presented  as  may  seem  desirable  for  the  use  of  the  party 
to  whom  the  report  is  submitted,  and  is  drawn  in  -such  form  as  seems 
most  intelligible  and  enlightening.  Such  a  report  may  be,  for  example, 
a  statement  of  the  financial  condition  of  the  business,  as  of  a  given 
date,  submitted  to  the  owners,  to  the  creditors,  or  to  a  governmental 
agency.  Or  it  may  be  a  statement  submitted  by  a  subordinate 
manager  to  the  general  manager  of  a  company,  setting  forth  his  plans 
for  the  coming  year,  or  a  statement  showing  the  results  of  the  opera- 
tions for  which  he  is  responsible  during  the  past  year.  Probably  this 
will  be  clarified  to  some  extent  by  the  discussion  which  follows  con- 
cerning the  need  of  such  reports  in  the  modern  business  organization. 

Reports  useful  to  various  interested  parties.  Assuming,  on  the 
basis  of  the  above  discussion,  that  the  matter  to  be  dealt  with  under 
the  head  of  accounting  has  to  do  with  the  use  of  business  reports,  the 
next  step  is  to  consider  from  what  various  points  of  view  data  need 
to  be  gathered  and  reports  prepared.  Who  are  the  parties  that  are 


4  PRINCIPLES  OF  ACCOUNTING 

interested  in  the  business,  and  what  is  the  nature  of  their  respective 
interests  ?  The  answer  to  this  question  may  help  to  explain  the  great 
increase  in  demand  for  trained  accountants  which  has  been  felt  in 
the  last  few  years. 

Not  more  than  fifty  years  ago  the  typical  business  organization  was 
one  with  a  relatively  small  amount  of  invested  capital.  This  capital 
was  in  most  cases  contributed  by  a  single  individual  or  by  a  small  and 
closely  connected  group.  Its  problems  of  management,  judged  by 
present  standards,  were  not  especially  complex,  and  were  dealt  with 
by  a  single  manager  or  by  a  small  group  who  were  responsible  for 
all  of  the  functions  of  the  business  enterprise,  and  who  found  little 
difficulty  in  being  familiar  with  most  of  the  details,  or  at  least  the 
significant  details,  of  the  business.  Outside  of  the  so-called  "public 
utility"  industries,  it  was  rarely  true  that  the  scope  of  the  business 
of  any  single  organization  was  so  wide  as  to  affect  vitally  any  large 
community  interest,  so  that  the  public  as  a  group  had  little  concern 
with  the  regulation  of  the  affairs  of  the  business. 

From  all  these  circumstances  it  followed  naturally  enough  that 
the  reports  required,  and  consequently  the  records  necessary  for  their 
preparation,  were  of  a  fairly  simple  type,  and  were  of  interest  to  only 
a  few  persons.  The  conventional  financial  reports,  setting  forth  the 
results  of  operations  hi  terms  of  general  financial  condition  and  of 
profit  and  loss,  were  entirely  adequate  to  the  needs  of  the  typical 
business  enterprise  of  the  period. 

Increased  size  has  meant  greater  complexity  in  business  organization. 
It  is  needless  to  point  out  that  very  great  changes  have  been  taking 
place  since  the  time  when  such  conditions  could  be  said  to  be  repre- 
sentative. A  large  number  of  business  enterprises  have  grown  up, 
each  of  which  represents  a  tremendously  large  capital  investment,  this 
investment  usually  being  made  on  varying  terms  by  a  large  number 
of  individuals.  Instead  of  the  owners  carrying  on  the  management  of 
the  business  themselves,  as  was  formerly  the  typical  case,  it  has 
become  necessary  for  the  management  to  be  intrusted  to  subordinates, 
men  of  special  training  in  their  particular  fields  of  management. 
A  president  or  general  manager  is  placed  in  charge  of  the  entire 
business,  being  held  responsible  by  the  owners,  and  he  in  turn  intrusts 
the  carrying  out  of  particular  functions  of  the  business  to  certain 
subordinate  managers,  who  report  to  him,  and  whom  he  holds  respon- 


THE  MEANING  AND  FUNCTION  OF  ACCOUNTING  5 

sible  for  the  proper  carrying  out  of  their  particular  functions.  Thus 
the  president  or  the  general  manager  might  well  have  subordinate 
to  him  and  reporting  to  him : 

1.  A  sales  manager,  who  would  be  in  charge  of  the  marketing 
of  the  products  or  services  upon  whose  sale  the  business  depends  for 
its  chief  revenue.    This  sales  manager  would  probably  also  have 
subordinates,  as,  for  example,  one  in  charge  of  domestic,  and  one  in 
charge  of  foreign,  sales.     Subordinate  to  or  co-ordinate  with  him, 
according  to  the  organization,  would  probably  be  the"  advertising 
manager,  with  his  staff. 

2.  A  merchandise  man,  or  manager  in  charge  of  purchases,  in 
the  case  of  a  business  which  buys  in  a  finished  state  the  product 
which  it  sells.     It  would  be  the  duty  of  this  man  to  have  general 
charge  of  the  task  of  obtaining  the  goods  which  are  to  be  sold,  and 
he  would  have,  in  a  large  business,  various  subordinates  who  are 
specialists  in  certain  types  of  merchandise  purchasing. 

3.  A  production  manager  in  a  manufacturing  business  who  is 
responsible  for  supplying  through  production  the  product  or  service 
necessary  to  supply  the  demands  of  the  customers.    The  purchasing 
of  materials  necessary  for  this  purpose  would  be  in  charge  of  a  general 
purchasing  agent  who  might  or  might  not  be  subordinate  to  the 
production  manager,  but  who  in  any  case  must  co-operate  with  him. 

4.  A  financial  manager,  who  is  responsible  for  the  formulation  and 
execution  of  the  financial  policy  of  the  business.     Usually  he  is  not 
given  final  authority  in  cases  of  great  importance,  but  it  is  his  duty 
to  provide  the  information  which  will  serve  as  a  basis  for  formulating 
the  financial  policy  of  the  business  and  to  execute  that  policy  after 
it  has  been  formulated.     Subordinate  to  the  financial  manager,  who 
is  sometimes  called  the  treasurer  or  comptroller,  there  may  be  a  credit 
manager  and  a  collection  manager.     In  any  case  there  must  be  close 
co-operation  between  the  financial  manager  and  those  who  guard  the 
credits  of  the  firm. 

5.  Miscellaneous  managers,  such  as  superintendent  of  buildings, 
operating  superintendent,  employment  manager,  etc.,  whose  titles 
indicate  their  duties. 

The  foregoing  list  of  subordinates  who  assist  the  president  or 
general  manager  in  the  formulation  and  execution  of  the  policies 
of  the  firm  is  intended  to  be  suggestive  rather  than  inclusive.  The 


6  PRINCIPLES  OF  ACCOUNTING 

ones  mentioned  are  those  who  are  necessary  to  supervise  and  control 
the  functions  which  are  common  to  businesses  in  general. 

It  is  not  intended  that  the  student  shall  gather  from  the  foregoing 
that  all  businesses  are  so  organized  that  one  man  is  placed  in  charge 
of  each  of  these  fields.  A  single  man  may,  of  course,  perform  all  of 
the  functions  suggested  above,  or  they  may  be  combined  in  any  way 
that  may  be  suggested  by  the  size  of  the  business  and  the  special 
abilities  of  the  men  who  are  in  the  particular  organization.  Thus  the 
president  might  be  also  the  comptroller,  while  the  sales  manager 
might  be  in  charge  of  the  credits  and  collections. 

Nature  of  reports  affected  by  functional  organization.  It  is  not 
difficult  to  see  that  in  a  business  organized  along  the  lines  indicated 
above,  there  would  be  need  for  reports  for  at  least  two  purposes: 

(i)  To  furnish  each  of  the  functional  managers  with  information 
that  would  enable  him  to  judge  how  well  his  subordinates  were  carry- 
ing out  their  duties,  and  to  aid  him  in  planning  and  carrying  out  his 
own  duties  in  a  successful  manner.  (2)  To  furnish  the  president  or 
general  manager  with  information  which  will  enable  him  to  evaluate 
the  success  of  the  work  done  by  his  subordinate  managers  in  the  period 
or  periods  covered  by  such  reports.  These  reports  should  also  supply 
him  with  such  information  as  will  furnish  a  basis  upon  which  to  plan 
for  the  conduct  of  business  operations  during  the,  coming  period,  and 
to  correlate  the  operations  of  the  various  subordinate  managers  in 
conformity  to  this  general  plan.  For  example,  when  he  has  con- 
sidered the  reports  of  past  perf ordnances,  and  the  plans  and  suggestions 
of  the  subordinate  managers  with  regard  to  operations  for  the  coming 
period  in  each  of  their  fields,  he  may  urge  the  sales  manager  to  try 
for  a  volume  of  sales  greater  than  that  of  the  period  just  past.  It  is 
possible,  also,  that  the  difficulty  of  financing  any  greater  volume  of 
sales,  as  indicated  by  the  financial  manager's  report,  or  the  difficulty 
of  securing  the  materials  or  labor  necessary  to  keep  up  the  quality 
of  the  product,  as  indicated  by  the  report  of  the  purchases  manager 
or  the  personnel  manager,  might  be  so  serious  as  to  lead  him  to  the 
conclusion  that  sales  must  be  held  at  the  level  of  the  last  period  or 
even  curtailed. 

The  gathering  and  interpreting  of  data  for  such  reports  as  have 
been  suggested  here,  namely,  reports  to  aid  in  solving  the  problems 
of  the  internal  management  of  the  business,  is  really  the  primary 


THE  MEANING  AND  FUNCTION  OF  ACCOUNTING  7 

function  of  accounting.  Accounting  justifies  itself  in  any  organization 
carried  on  for  purposes  of  making  a  profit  only  as  it  serves  as  an  aid  in 
maintaining  the  investment  in  the  business  and  in  earning  an  adequate 
return  upon  that  investment.  It  is  therefore  upon  the  use  of  accounts 
as  an  aid  to  management  that  emphasis  will  be  placed  in  this  text. 

Reports  required  by  owners  and  prospective  investors.  While  report- 
ing for  managerial  purposes  is  the  chief  function  of  accounting,  there 
are  also  other  interested  parties  to  whom  reports  must  be  submitted. 
The  various  parties  who  have  investments  in  the  business  desire  to 
be  able  to  evaluate  the  profitableness  of  that  investment  and  the 
desirability  of  continuing  it  or  of  adding  to  it.  Also,  it  may  be  found 
desirable  to  interest  additional  investors  and  thus  secure  additional 
capital  to  extend  the  business  and  place  it  on  a  more  profitable  basis. 
Needless  to  say,  the  prospective  investor  would  demand  that  infor- 
mation be  furnished  him  which  would  give  him  some  idea  of  the  con- 
dition and  earning  power  of  the  business  before  he  would  risk  his 
funds  by  investing  them  therein. 

Investments  in  the  modern  business  enterprise  are  made  on  a 
variety  of  terms.  Different  classes  of  investors  have  different  kinds 
of  claims  on  the  business,  with  respect  to  the  amount  of  income  they 
may  expect,  the  guaranty  for  the  payment  of  that  income  to  them, 
the  conditions  under  which  their  investment  is  to  be  returned  to  them, 
and  the  security  which  they  have  for  the  safety  of  the  investment. 
Most  of  the  students  who  read  this  text  are  familiar  in  a  general  way 
with  the  nature  of  the  contract  between  the  investors  and  the  average 
corporation  when  the  latter  issues  any  of  the  usual  types  of  securities. 
There  are  marked  points  of  difference  in  the  claims  on  both  capital 
and  income  among  the  holders  of  the  most  common  types  of  corpora- 
tion securities,  such  as  common  stock,  preferred  stock,  whether  cumu- 
lative or  non-cumulative,  mortgage  bonds,  collateral  trust  bonds, 
equipment  trust  certificates,  a"hd  so  on. 

It  follows  from  all  this  that  the  accounts  must  be  kept  not  only 
for  the  use  of  the  internal  managerial  organization,  but  also  in  such  a 
manner  as  to  permit  the  preparation  of  reports  that  will  set  forth 
clearly  the  status  of  each  of  the  different  classes  of  investors,  not  only 
to  protect  the  rights  of  each  class  in  the  distribution  of  net  profit, 
but  also  to  enable  each  to  estimate  closely  the  value  of  his  investment 
or  proposed  investment. 


8  PRINCIPLES  OF  ACCOUNTING 

Creditors  require  reports.  Another  class  which  is  keenly  interested 
in  the  financial  and  operating  health  of  the  business  enterprise  is  that 
of  the  creditors.  There  are  two  chief  kinds  of  creditors,  besides  the 
bondholders,  who  have  been  included  among  the  investors,  though 
strictly  speaking  they  are  really  long-tune  creditors.  The  two  kinds 
of  short-time  creditors  are:  (i)  trade  creditors  and  (2)  commercial 
banks.  Both  classes  typically  require  reports  setting  forth  the 
financial  condition  of  the  concerns  which  apply  to  them  for  credit. 
Some  commercial  credit  agencies  and  many  banks  have  standard 
forms  upon  which  applicants  for  credit  are  required  to  make  reports. 
The  emphasis  hi  these  reports  is  somewhat  different  from  that  in 
reports  to  owners  and  long-tune  creditors  like  bondholders,  but  on  the 
whole  they  usually  contain  about  the  same  information  as  the  latter. 
Neither  type  of  report  presents  anything  like  as  difficult  a  problem 
in  accounting  as  the  first  class  mentioned,  namehy,  the  reports  for 
managerial  purposes. 

The  public  an  interested  party.  Such  a  business  as  we  are  discussing 
may  be  of  such  importance,  owing  to  its  size  or  to  the  nature  of  its 
product,  that  it  involves  a  public  interest  in  the  way  the  business  is 
carried  on.  There  is  nothing  new  or  strange  about  this  as  applied  to 
the  so-called  "utilities,"  such  as  the  common  carriers,  the  gas  and 
electric  companies,  etc.  In  the  case  of  these  businesses  it  is  recognized 
that  the  public  is  vitally  concerned,  and  regulation  is  undertaken 
with  the  double  purpose  of  making  sure  (i)  that  the  service  rendered  is 
adequate  and  satisfactory  in  quality,  and  (2)  that  it  is  rendered  at  a 
reasonable  rate.  It  is  easy  to  see  that  no  regulatory  body  could  hope 
to  accomplish  much  along  the  lines  indicated  unless  they  were  fur- 
nished with  reports  showing  the  amount  of  investment  in  the  company 
in  question  along  with  its  earnings  and  expenses.  Otherwise  they 
would  certainly  be  in  no  position  to  judge  whether  the  company  was 
earning  enough  to  pay  its  investors  a  return  sufficient  to  keep  their 
capital  in  the  business  over  a  long  period  and  to  attract  additional 
capital  as  it  is  needed  in  order  to  keep  pace  adequately  with  the 
demands  of  the  public  for  the  goods  or  services  in  question.  As  a 
result  we  find  that  practically  every  company  of  this  character  is 
required  by  some  regulatory  body  to  make  reports  on  standardized 
forms  at  certain  times.  The  records  which  must  be  kept  in  order  to 


THE  MEANING  AND  FUNCTION  OF  ACCOUNTING  g 

prepare  these  reports  are  as  a  rule  such  as  would  serve  well  enough 
as  a  basis  for  the  preparation  of  reports  to  investors  or  to  creditors, 
but  they  would  not  furnish  a  sufficiently  detailed  analysis  for  purposes 
of  managerial  reporting. 

The  necessity  of  reporting  to  government  agencies  is  not  confined 
to  the  utilities,  however,  but  extends  now  to  practically  every  business 
enterprise.  The  requirements  of  reporting  for  the  purpose  of  the 
income,  excess-profits,  and  war-profits  taxes  have  practically  forced 
even  the  smaller  businesses  into  some  sort  of  record-keeping.  During 
the  war  the  interest  of  society  as  a  whole  in  the  individual  business 
reached  a  point  of  development  previously  unknown.  The  raw 
materials  and  supplies  used,  the  transportation  facilities,  the  labor 
supply,  the  financing,  the  disposal  of  the  product,  and  the  rate  of 
profit,  all  received  the  attention  of  the  government  as  the  exigencies 
of  the  war  seemed  to  make  it  desirable.  It  is  fairly  safe  to  predict 
that  in  the  future  two  things  will  be  true  as  a  result  of  this  war-time 
regulation.  In  the  first  place,  there  will  be  a  greater  degree  of  govern- 
ment regulation  of  private  business  than  in  the  past,  necessitating 
for  many  businesses  more  complete  records  than  they  had  formerly 
kept.  Secondly,  many  small  businesses,  having  had  the  matter  of 
reporting  forced  upon  their  attention,  will  come  to  realize  its  impor- 
tance and  will  in  the  future  maintain  more  adequate  systems  of  records 
and  will  make  more  use  of  reports  within  the  business. 

Summary  of  parties  requiring  reports.     To  summarize  the  dis- 
cussion with  regard  to  the  various  parties  interested  in  the  modern 
business  and  demanding  reports  prepared  from  the  records  kept  in 
that  business,  these  interested  parties  may  be  indicated  as  follows: 
i.  The  managerial  staff 

a)  President,  or  general  manager 

b)  Sales  manager 

c)  Head  merchandise  man,  or  purchases  manager  (in  a  commer- 

.cial  business) 

d)  Factory  superintendent,  or  production  manager  (in  a  manu- 

facturing business) 

e)  Comptroller,  or  financial  manager 

/)  Other  functional  managers,  varying  with  the  organization  of 
the  business 


10  PRINCIPLES  OF  ACCOUNTING 

2.  Investors,  present  and  prospective 

a)  Stockholders,  of  various  classes 

b)  Bondholders,  also  of  various  classes 

3.  The  creditors 

a)  Trade  creditors 

b)  Commercial  banks 

c)  Other  creditors 

4.  The  government 

a)  For  regulation  of  the  price 

6)  For  regulation  of  the  quality 

c)  For  purposes  of  taxation 

d)  For  purposes  of  limitation  on  the  amounts  of  certain  materials 

and  services  that  can  be  used 

e)  For  the  protection  of  those  employed — regulation  of  hours 

wages,  working  conditions,  child  labor,  female  labor,  etc. 

A  ccouniant's  task  to  gather  data  atid  prepare  reports.  The  purpose  of 
going  into  the  foregoing  discussion  with  regard  to  the  parties  who 
require  reports  on  various  phases  of  the  modern  business  has  been 
that  of  giving  the  student  some,  idea  of  the  increasingly  broad  field 
in  which  the  accountant  may  work.  Given  a  certain  type  of  business 
organization,  with  certain  relations  to  its  investors,  to  its  creditors, 
and  to  the  public  in  general,  it  is  the  accountant's  task  to  determine 
what  forms  of  reports  will  best  serve  the  various  purposes  for  which 
reports  are  needed,  to  ascertain  what  data  will  need  to  be  gathered 
to  serve  as  a  basis  for  the  preparation  of  these  reports,  to  design  a 
system  of  records  which  will  facilitate  the  gathering  and  necessary 
analysis  of  this  data,  and  finally  to  prepare  from  the  data  thus 
gathered  the  reports  and  schedules  determined  upon.  That  this 
task  is  not  an  insignificant  or  an  easy  one  will  be  realized  by  the 
student  as  he  goes  farther  in  the  study  of  accounting. 

To  prepare  him  for  this  task  several  things  are  necessary:  (i)  He 
must  acquire  some  insight  into  the  nature  of  the  problems  in  the 
solution  of  which  the  business  executive  may  reasonably  expect  aid 
from  the  accountant.  (2)  He  must  have  some  idea  of  the  type  of 
information  which  will  be  helpful  in  solving  these  problems,  and  of 
the  forms  of  reports  in  which  this  information  may  be  presented. 
(3)  He  must  understand  the  analysis  necessary  to  make  available  the 
desired  information,  and  the  various  possible  bases  upon  which  this 


THE  MEANING  AND  FUNCTION  OF  ACCOUNTING      1 1 

analysis  may  be  made.  (4)  He  must  learn  how  to  design  forms  of 
records  which  will  enable  him  to  provide  for  the  recording  of  individual 
business  transactions,  evidenced  by  various  types  of  business  papers 
involved,  hi  such  a  way  as  to  make  readily  possible  the  analysis  which 
has  been  decided  upon  as  desirable. 

Keeping  in  mind,  then,  the  broad  field  that  has  been  outlined 
above  as  the  province  of  the  accountant,  the  student  must  content 
himself  for  the  present  to  deal  with  reports  only  as  typified  by  certain 
simple  and  conventional  kinds.  These  simple,  conventional  types 
will  be  studied,  together  with  certain  conventional  types  of  records 
used  in  gathering  the  information  needed  for  them,  with  the  aim  of 
familiarizing  the  student  with  certain  more  or  less  standard  termi- 
nology and  technique  of  accounting.  If  this  aim  can  be  successfully 
accomplished  in  the  earlier  part  of  the  course,  he  will  at  that  time  have 
acquired  not  only  this  necessary  technique  but  also  some  insight 
into  the  construction,  meaning,  and  function  of  the  reports  as  typified 
by  the  simpler  forms  which  he  has  studied,  and  will  be  ready  to  proceed 
to  more  specialized  problems. 


QUESTIONS  FOR  CLASS  DISCUSSION 

1.  In  elementary  courses  in  accounting  there  are  usually  three  classes  of 
students:   (a)  those  who  are  interested  in  accounting  as  a  part  of  a 
general  business  training;   (b)  those  who  are  interested  in  accounting  as 
an  instrument  of  social  control;  and  (c)  those  who  desire  to  prepare  for 
the  professional  practice  of  accounting.   Should  the  preliminary  training 
in  accounting  of  all  of  these  be  the  same  or  different  ?    Why  ? 

2.  Explain  and  illustrate  how  accounting  is  related  to  business  management. 

3.  The  Brown  Steel  Company  has  its  general  offices  in  New  York.    It  has 
ten  subsidiary  companies  operating  in  ten  different  states.    What  is 
necessary  in  order  to  enable  the  general  manager  at  New  York  to  exercise 
control  over  the  operations  of  the  subsidiary  companies  ? 

4.  In  what  way  has   the   development   of  large  business  organizations 
affected  the  problem  of  business  control  or  management  ? 

5.  Illustrate  how  this  change  in  business  management  has  affected  the 
development  and  use  of  accounting. 

6.  What  will  be  the  probable  tendency  with  reference  to  the  need  and  use  of 
accounting  in  the  future  ?    Give  illustrations  and  evidence  to  support 
your  answer. 


12  PRINCIPLES  OF  ACCOUNTING 

7.  Large  companies  sell  their  bonds  and  stocks  in  many  markets  and  to 
many  people.      How  do  these  purchasers  determine  the  financial  relia- 
bility of  the  firm  issuing  such  bonds  and  stocks  ? 

8.  How  does  the  credit  manager  of  a  wholesale  business  determine  the 
financial  condition  and  credit  standing  of  the  retailers  who  purchase 
from  his  company  ? 

9.  Explain  and  illustrate  how  the  government  may  be  interested  in  the 
business  affairs  of  the  individual  business.     In  what  way  does  the 
government    obtain    the    information    which    it    desires    from    such 
businesses  ? 

10.  State  and  illustrate  some  of  the  things  which  the  accountant  needs  to 
know  in  addition  to  the  technique  of  record  keeping.    Why  does  he 
need  to  know  them  ? 

11.  How  does  accounting  help  to  reduce  the  inevitable  risks  of  modern 
business  ? 

1 2.  Why  should  a  manager  understand  the  technique  of  preparing  account- 
ing reports  when  he  will  not  be  called  on  to  prepare  them  himself  ? 

REFERENCES  FOR  FURTHER  STUDY 

PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  chap.  i. 
GREENDLINGER,  LEO,  Financial  and  Business  Statements,  chap.  i. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  i. 
WILDMAN,  JOHN  R.,  Principles  of  Accounting,  chaps,  i,  ii,  and  iii. 


CHAPTER  II 


The  basis  of  business  management.  In  chapter  i  an  attempt  was 
made  to  give  a  view  of  the  field  of  accounting  in  rather  a  broad  way 
and  to  give  some  idea  of  the  place  of  the  accountant  among  those 
who  exercise  guidance  in  modern  industrial  society.  In  that  con- 
nection it  was  pointed  out  that  the  primary  function  of  the  accountant 
is  to  make  available  for  the  various  parties  interested  in  the  business 
enterprise  such  reports  as  are  useful  to  them  in  the  management  or 
control  of  the  business.  In  this  discussion  the  principal  emphasis 
was  placed  on  the  use  of  such  reports  as  an  aid  to  management,  and  it 
was  seen  that  the  special  problems  of  management  are  very  likely 
to  be  dealt  with  by  a  number  of  men,  each  a  specialist  in  his  particular 
line.  The  ultimate  control  of  the  business,  however,  is  exercised 
directly  or  indirectly  by  the  owner  of  the  business  or  by  the  executive 
head,  to  whom  the  owner  delegates  certain  powers.  It  is  necessary, 
therefore,  for  accounting  to  give  the  owner  or  executive  manager  the 
information  which  he  needs  to  manage  his  business.  In  order  to 
understand  how  accounting  may  do  this,  it  is  desirable  to  consider 
the  nature  of  the  information  which  he  should  have. 

The  information  which  the  owner  of  a  business  needs  in  order  to 
manage  it  so  that  a  profit  may  result  may  be  classified  as  follows: 
(i)  information  concerning  the  property  employed  in  the  conduct 
of  the  business,  i.e.,  the  things  which  the  owner  uses  in  the  carrying 
on  of  the  business,  such  as  cash,  merchandise,  furniture,  land,  build- 
ings, etc.;  (2)  information  concerning  the  operations  he  performs, 
i.e.,  the  activities  in  which  he  engages,  such  as  buying  and  selling 
goods  and  paying  expenses. 

It  is  customary,  therefore,  for  the  owner  to  request  from  his 
accounting  department  at  the  end  of  certain  periods  of  time  two 
reports  or  statements.  The  first  sets  forth  the  nature  and  value  of 
the  property  which  he  is  using  in  the  business.  The  second  furnishes 

13 


14  PRINCIPLES  OF  ACCOUNTING 

him  with  information  concerning  the  operations  which  the  business 
has  performed,  i.e.,  the  things  which  it  has  done  during  the  period 
and  the  result  of  these  operations.  The  purpose  of  both  of  these  reports 
is  the  same — to  give  the  owner  information  which  will  enable  him  to 
manage  his  business  in  such  a  manner  as  to  make  a  profit. 

The  first  report  indicates  to  the  owner  the  property  which  he 
may  use  in  the  conduct  of  the  business.  The  second  report  reveals 
to  him  the  results  of  its  use  during  the  past  period  and  from  these 
results  he  can  judge  the  best  way  to  use  it  during  the  coming  period. 
It  can  be  seen,  therefore,  that  these  reports  serve  as  a  basis  of  manage- 
ment by  the  owner. 

In  the  following  chapters  it  is  intended  to  consider  the  nature  of 
the  information  which  should  be  contained  hi  these  two  reports  which 
may  be  taken  as  typical  of  other  reports  to  be  considered  later.  Con- 
sideration will  also  be  given  to  the  form  in  which  this  information 
may  be  presented  advantageously  and  to  the  types  of  records  necessary 
to  gather  the  data  needed,  and  the  methods  employed  in  gathering 
these  data  and  interpreting  them  for  the  purposes  of  the  reports 
under  consideration.  It  must  be  borne  in  mind  that  these  two  re- 
ports, while  they  are  the  ones  most  generally  used,  are  typical  of 
others  which  are  equally  useful  in  the  proper  management  of  the 
modern  business.  It  is  desirable,  however,  to  postpone  the  detailed 
discussion  of  other  forms  until  later,  when  the  student  will  be  better 
prepared  to  understand  their  uses  and  the  technique  of  accounting 
involved  in  their  preparation. 

Business  investment  implies  existence  of  assets  and  liabilities.  In 
carrying  on  any  business  enterprise,  a  certain  amount  of  property 
must  be  in  use  at  any  given  time.  In  the  terminology  of  the  business 
world,  such  property  is  known  as  the  assets  of  a  business.  An  asset 
may  be  defined  as  any  property  of  the  owner  which  he  uses  or  employs 
in  the  conduct  of  his  business.  This  does  not  necessarily  mean  that 
it  must  always  be  in  active  use.  Property  may  be  held  in  the  business 
for  a  time  without  being  put  to  such  use  and  still  be  counted  as  an 
asset  to  the  business.  The  surplus  funds  may  be  invested  hi  securi- 
ties and  even  in  real  estate  until  the  time  when  they  are  needed  in  the 
more  active  conduct  of  the  business,  but  this  property  is  still  used  to 
serve  the  purposes  of  the  owner  in  the  conduct  of  the  business  and  is 
an  asset.  Thus,  if  W.  A.  Williams  is  conducting  a  retail  store,  the 


RELATIONSHIP  OF  ACCOUNTING  TO  PROPRIETORSHIP         1$ 

assets  of  his  business  may  include  building  and  equipment,  stock  of 
merchandise,,  the  amounts  owed  by  customers,  the  bank  balance, 
and  anything  else  of  value  belonging  to  the  business. 

It  often  happens  that  the  owner  is  not  able  to  make  a  sufficiently 
large  investment  to  enable  the  operations  of  the  business  to  be  carried 
on  in  the  most  profitable  fashion.  In  such  a  case  it  becomes  desirable 
to  obtain  from  outside  parties  the  additional  property  required.  This 
is  done  by  securing  some  form  of  credit.  This  credit  may  take  the 
form  of  borrowing  money  for  a  long  period,  protecting  the  interests 
of  the  creditor  by  some  sort  of  a  lien  on  the  assets  of  the  business,  and 
using  the  money  to  purchase  the  property  needed.  It  may  take  the 
form  of  borrowing  from  the  bank  for  a  short  time  to  supply  a  tempo- 
rary need,  or  it  may  take  the  form  of  purchasing  merchandise,  sup- 
plies, property,  or  services  with  the  privilege  of  deferring  payment 
for  a  short  time. 

Obtaining  property  from  others  in  any  such  manner  results  in 
giving  the  one  who  extends  the  credit  a  claim  against  the  assets  of  the 
business.  Such  a  claim  is,  from  the  point  of  view  of  the  owner  of  the 
business,  a  liability.  A  liability  may  be  defined  for  present  purposes 
as  a  legally  enforceable  claim  upon  the  assets  of  a  business.  It  is  a 
claim  upon  the  assets  in  the  sense  that  sooner  or  later  it  must  be 
satisfied  by  turning  over  to  the  creditor  a  certain  part  of  the  assets, 
usually  in  the  form  of  cash.  For  instance,  if  W.  A.  Williams  pur- 
chases merchandise  and  supplies  for  which  he  promises  to  pay  in 
thirty  days,  he  incurs  a  liability,  since  those  from  whom  he  purchases 
have  a  claim  on  his  assets  until  he  pays  for  these  goods. 

Proprietorship.  Therefore  the  owner  in  estimating  the  true 
worth  of  his  property  or  assets  invested  in  the  business  must  always 
take  into  consideration  the  liabilities  which  are  claims  against  these 
assets.  If  W.  A.  Williams,  the  retail  merchant,  employs  in  the  con- 
duct of  his  store  cash  to  the  amount  of  $1,500;  merchandise  to  the 
amount  of  $3,600;  show  cases,  counters,  and  store  furniture  worth 
$500;  and  equipment  used  in  delivering  goods  to  customers  worth 
$400;  he  is  using  a  total  of  $6,000  of  assets  in  his  business.  If,  how- 
ever, he  owes  trade  creditors  $1,000,  he  must  take  this  amount  into 
consideration  when  he  is  thinking  about  his  business.  His  net  assets 
or  the  amount  which  he  would  have  after  paying  his  liabilities  amount 
to  only  $5,000.  This  $5,000,  or  the  difference  between  his  assets 


16  PRINCIPLES  OF  ACCOUNTING 

and  liabilities,  is  known  in  accounting  as  his  net  worth  or  proprietor- 
ship. It  represents  the  interest  of  the  owner  in  the  business.  Report- 
ing with  regard  to  proprietorship  and  the  records  necessary  for  such 
reporting  are  of  great  importance  in  accounting  and  will  receive 
considerable  attention  hi  the  following  chapters. 

Object  of  business  operations  to  increase  proprietorship.  To  under- 
stand better  the  importance  of  proprietorship  it  may  be  well  to  give 
some  further  consideration  at  this  point  to  its  nature  and  significance. 
It  should  have  been  made  clear  that  it  is  the  excess  of  total  assets  over 
total  liabilities  and  represents  the  net  investment  of  the  owner  or 
owning  group.  Any  increase  hi  the  amount  of  proprietorship  which 
takes  place  during  a  given  period,  exclusive  of  any  additional  invest- 
ment which  may  be  made  during  that  period  by  the  owner,  is  known 
as  the  net  income  of  the  business  for  the  period.  In  case  such  net 
income  is  earned  by  the  business,  it  is  then  possible  for  the  owner  to 
withdraw  from  the  business  for  his  private  use  assets  to  the  amount 
of  such  increase  in  proprietorship  without  thereby  impairing  his 
original  investment.  It  is  only  through  net  income  that  the  return 
to  the  owner,  which  is  his  inducement  for  making  the  original  invest- 
ment, is  made  possible.  The  disposal  of  this  excess  of  assets  over 
liabilities  is  of  course  optional  with  the  owner.  He  may  withdraw 
it  all  or  any  part  of  it,  or  he  may  allow  all  or  any  part  of  it  to  continue 
hi  use  hi  the  operations  of  the  business.  In  any  case,  he  has  increased 
the  amount  of  his  ownership.  He  has  realized  a  profit,  and  this  is 
the  object  of  his  investment. 

In  the  illustration  given  under  the  discussion  of  proprietorship, 
W.  A.  Williams  is  using  $6,000  of  property  in  operating  his  grocery 
store.  Others  have  a  claim  against  this  property  for  $1,000,  there- 
fore his  interest  or  ownership  in  the  business  amounts  to  $5,000.  If 
a  year  later  the  total  property  invested  in  the  business  amounts  to 
$8,000  and  his  liabilities  amount  to  $2,000,  he  has  an  interest  in  the 
business  of  $6,000,  or  $1,000  more  than  at  the  beginning  of  the  year.1 

It  need  scarcely  be  pointed  out  that  the  main  object  of  the  owner 
hi  conducting  the  business  is  to  increase  the  amount  of  proprietorship 

'He  may  withdraw  this  $1,000  from  the  business  and  the  business  will  be  in 
the  same  condition  as  at  the  beginning  of  the  year,  or  he  may  decide  to  leave  it 
in  the  business,  hoping  that  by  the  use  of  the  additional  $1,000  of  property  he 
may  increase  his  proprietorship  during  the  coming  year  more  than  during  the  past 
year. 


RELATIONSHIP  OF  ACCOUNTING  TO  PROPRIETORSHIP        17 

at  as  rapid  a  rate  as  possible,  since  that  is  the  motive  back  of  business 
enterprise  under  our  present  economic  organization.  The  information 
desired  by  the  owner  with  reference  to  the  business,  therefore,  will  be 
such  as  will  enable  him  so  to  manipulate  the  assets  and  control  the 
liabilities  as  to  earn  the  highest  possible  rate  of  profit,  or  increase, 
in  proprietorship.  It  is  the  primary  object  of  accounting,  therefore, 
to  give  this  information. 

Proprietorship  the  excess  of  assets  over  liabilities.  As  previously 
indicated,  the  amount  of  the  owner's  interest  or  his  proprietorship 
can  be  obtained  at  any  time  by  subtracting  the  total  amount  of  his 
liabilities  from  the  total  amount  of  his  assets.  To  take  a  more 
detailed  illustration  than  the  one  given  above,  the  assets  of  W.  A. 
Williams  may  be  as  follows :  Cash,  $i  ,500 ;  debts  due  from  customers 
to  whom  merchandise  has  been  sold  on  credit,  $3,040;  merchandise 
on  hand,  $3,500;  office  and  store  furniture  and  equipment,  $450; 
delivery  equipment,  $640.  By  adding  the  above  items  it  will  be  seen 
that  the  total  assets  of  Williams  will  amount  to  $9,130.  If  he  owes 
creditors  from  whom  he  has  purchased  merchandise  $1,500,  his 
liabilities  are  $1,500  and  his  net  worth  or  proprietorship  $7,630. 

The  assets,  liabilities,  and  proprietorship  of  Williams  may  be 
shown  by  the  following  statement : 

ASSETS 

Cash $1,500.00 

Debts  owing  from  customers      .       .       .  3,040.00 

Merchandise  on  hand  .       .       ...       .  3,500.00 

Furniture  and  fixtures         ....  450.00 

Delivery  equipment     .....  640.00 

Total  assets $9,130.00 

LIABILITIES 

Debts  to  merchandise  creditors         ....          $1,500.00 


Net  worth  of  proprietorship       ....          $7,630.00 

Such  a  statement  as  this  is  valuable  to  the  owner  from  more  than 
one  point  of  view.  First,  it  shows  him  the  amount  of  his  net  worth 
so  that  he  can  tell  whether  his  investment  has  been  increased  or 
impaired.  Secondly,  it  shows  him  the  amount  and  nature  of  the 


i8  PRINCIPLES  OF  ACCOUNTING 

assets  in  the  business  and  the  amount  and  nature  of  the  liabilities. 
Such  a  statement  may  be  used  by  the  owner,  not  only  to  determine 
the  status  of  his  investment,  but  also  to  aid  him  in  planning  such  a 
policy  for  the  future  conduct  of  the  business  as  seems  likely  to  bring 
about  further  increases  in  proprietorship.  Only  a  small  part  of  the 
work  of  the  accountant  lies  in  showing  what  has  taken  place  and  the 
condition  resulting  from  past  operations.  It  is  necessary  to  show 
this,  but  the  real  object  in  so  doing,  from  the  point  of  view  of  manage- 
ment, is  to  aid  hi  the  planning  of  future  operations.  Accordingly  a 
statement  showing  the  amount  and  kind  of  assets,  the  amount  and 
kind  of  liabilities,  and  the  amount  and  kind  of  proprietorship  should 
furnish  the  owner  with  such  information  concerning  the  nature  of 
the  assets  and  the  claims  against  them  as  will  suggest  certain  possible 
courses  of  action  in  handling  them  during  the  coming  period  of 
operations. 

Proprietorship  may  assume  various  forms.  The  foregoing  discussion 
of  proprietorship  has  used  as  an  example  the  single  proprietorship 
business,  which  is  the  form  involving  the  fewest  legal  compli- 
cations. Besides  the  single  proprietorship,  however,  a  number  of 
other  forms  of  proprietorship  have  been  used,  most  of  which  can 
still  be  found  in  use.  The  forms  of  proprietorship  which  are  in  com- 
mon use  today  may  be  divided  into  three  main  types,  which  may  be 
represented  by:  (i)  the  single  proprietorship,  (2)  the  partnership,  and 
(3)  the  corporation.  .  For  this  reason  it  is  desirable  to  discuss  briefly 
certain  of  the  characteristic  features  of  each  of  these  three  forms  of 
proprietorship. 

Single  proprietor  needs  reports  for  control.  In  the  case  of  a  business 
owned  by  an  individual  proprietor,  there  is  usually  a  distinction  to  be 
made  by  the  accountant  between  the  proprietor's  net  ownership 
in  the  business  and  his  property  interests  outside  the  business.  The 
report  made  by  the  accountant  on  the  status  of  the  investment  in  a 
given  business  enterprise  will  deal  only  with  the  assets  used  in  carrying 
on  £hat  business,  the  claims  of  creditors  upon  those  assets,  and  the 
resulting  net  worth  of  the  owner  or  owners.  For  purposes  of  control 
by  the  owner  it  is  important  that  the  facts  shown  should  be  so  limited. 
The  proprietor  should  be  able  to  judge  of  the  relative  success  of  his 
business,  or  of  each  of  several  businesses  which  he  may  own,  by 
comparing  the  amount  of  the  changes  in  proprietorship  with  the 


RELATIONSHIP  OF  ACCOUNTING  TO  PROPRIETORSHIP         19 

amount  of  his  net  investment  in  each  such  enterprise.  If  he  has  the 
information  which  will  enable  him  to  make  such  comparisons,  he  is  in  a 
position  to  decide  intelligently  what  course  of  action  will  be  likely 
to  prove  most  profitable  with  regard  to  a  given  business.  His  decision 
may  be  to  continue  the  present  investment,  to  add  to  it,  to  withdraw 
a  part  of  it,  or  to  withdraw  it  altogether  as  soon  as  is  practicable. 
In  any  case  it  is  desirable  that  he  should  be  aided  in  reaching  his 
decision  by  a  separate  report  on  each  business  enterprise  in  which  he 
is  interested  as  an  owner. 

At  the  same  time,  so  far  as  his  creditors  are  concerned,  there  is 
little  if  any  reason  for  such  distinction,  since  the  law  does  not  recognize 
any  business  undertaking  of  a  single  proprietor  as  an  entity  separate 
from  his  ownership  in  other  capacities.  All  his  Creditors,  whether 
they  are  creditors  of  a  business  owned  by  him  or  creditors  of  the  pro- 
prietor in  his  private  capacity,  may  consider  all  his  assets,  no  matter 
how  they  are  invested,  as  a  common  fund  to  which  they  may  look 
for  the  satisfaction  of  their  claims. 

Partnership  form  involves  additional  considerations.  The  principle 
involved  in  recording  the  proprietorship  of  a  partnership  is  no  differ- 
ent from  that  involved  in  the  individual  proprietorship.  The  only 
difficulty  here  is  in  keeping  distinct  the  respective  investments  of  the 
two  or  more  partners.  Their  respective  share  in  the  proprietorship 
may  of  course  be  decreased  by  withdrawals  or  increased  by  additional 
investments,  and  will  be  increased  or  decreased  by  the  rise  or  fall  in 
amount  of  the  net  assets  of  the  firm,  in  proportions  previously  deter- 
mined by  the  partnership  agreement. 

The  law  does  not  recognize  a  partnership  as  a  legal  entity,  but 
recognizes  only  the  individuals  who  are  associated  in  the  partnership, 
and  their  legal  rights  and  duties  as  regards  their  relations  to  one 
another  and  to  others.  In  the  ordinary  partnership,  the  creditors 
may  look  not  only  to  the  business  assets  but  to  the  property  of  the 
individual  partners  outside  the  business,  just  as  in  the  case  of  an 
individual  proprietor. 

In  the  case  of  the  partnership,  however,  the  partnership  creditors 
must,  hi  case  of  insolvency,  use  up  the  partnership  assets  before 
turning  to  the  individual  property  of  the  partners  held  outside  the 
partnership"  and  conversely,  the  personal  creditors  of  the  partners 
must  content  themselves  with  the  assets  of  the  individual  partner 


20  PRINCIPLES  OF  ACCOUNTING 

outside  the  partnership  holdings  until  these  are  exhausted,  before 
turning  to  the  firm  assets. 

There  are  a  number  of  peculiarities  and  problems  that  arise  in 
actual  practice  in  dealing  with  the  records  of  a  partnership,  which 
belong  peculiarly  to  that  form  of  organization,  and  which  arise  in 
very  large  part  out  of  the  nature  of  the  partnership  agreement,  but 
it  is  scarcely  worth  while  to  take  these  up  at  this  point,  as  they  can  be 
better  treated  somewhat  farther  on  when  the  student  has  more 
knowledge  of  the  technique  of  accounts. 

Corporation  typically  a  modern  form.  The  corporation  as  a  form 
of  business  organization  is  a  creation  of  statutory  law,  a  form  which 
has  been  gradually  developed  to  its  present  status  by  the  needs  which 
have  arisen  with*  the  development  of  the  industrial  order.  The 
modern  industrial  order  has  made  necessary  the  employment  of  very 
large  amounts  of  invested  capital,  and  this  fact  has  made  certain 
features  of  organization  desirable,  if  not  indeed  essential.  A  form  of 
organization  was  needed  in  which  (i)  capital  contributions  could  be 
secured  in  varying  amounts  from  a  great  variety  of  sources,  (2)  the 
investor  should  not  be  liable  to  creditors  of  the  concern  to  the  full 
extent  of  his  private  fortune,  (3)  control  and  management,  while 
vested  in  the  last  analysis  in  the  owners,  could  be  delegated  to  a  cen- 
tralized group,  the  members  of  which  should  be  chosen  for  their 
special  ability  to  deal  with  the  peculiar  problems  in  the  particular 
business  in  question,  and  in  which  (4)  any  owner  who  desired  to  with- 
draw his  investment  from  the  business  could  do  so  simply  by  trans- 
ferring all  or  any  part  of  his  investment  to  another  person  without  in 
any  way  disorganizing  the  business. 

In  attempting  to  meet  these  needs  the  modern  corporate  form  of 
business  organization  has  been  developed.  It  is  a  legal  entity  and 
has  a  separate  existence  as  a  legal  person  apart  from  any  of  its  owners, 
with  practically  the  rights,  from  a  business  point  of  view,  which  are 
enjoyed  by  any  citizen.  The  corporation  as  it  now  exists  is  not  to 
be  taken  as  the  last  word  in  business  organization.  There  are  still  some 
problems  relating  to  the  financing  of  the  business  enterprise  and  to 
the  protection  of  the  various  interests  involved  which  have  not  been 
satisfactorily  worked  out  under  the  corporate  form  of  organization. 
Whether  the  needed  reforms  will  eventually  come  about  through  a 
modification  of  the  present  corporation  laws  or  through  a  different 


RELATIONSHIP  OF  ACCOUNTING  TO  PROPRIETORSHIP        31 

form  of  organization  is  at  present  scarcely  a  profitable  subject  for 
discussion. 

The  ascertainment  of  proprietorship  in  a  corporation  involves 
exactly  the  same  issues  as  in  the  individual  proprietorship.  The  only 
difficulties  that  arise  in  showing  it  in  the  case  of  the  corporation  arise 
from  the  fact  that  the  owners  are  numerous  and  their  investments 
are  often  made  on  varying  terms.  There  may  be  several  groups  among 
them,  each  having  an  interest  in  the  total  proprietorship  that  differs 
in  some  way  from  that  of  the  other  groups.  It  is  not  desirable  to 
enter  into  any  further  discussion  of  the  problems  thus  arising,  since 
they  will  be  handled  later  and  since  for  the  present  the  principles  of 
proprietorship  may  be  quite  amply  illustrated  by  the  use  of  illustra- 
tions drawn  from  the  business  of  a  single  proprietor. 

Summary.  The  point  of  primary  importance  for  the  student  to 
bear  in  mind  at  the  present  time  is  that  the  function  of  accounting 
is  to  provide  information  which  can  be  used  by  those  hi  charge  of  the 
management  of  the  business  to  increase  the  proprietorship  interest, 
whether  that  interest  be  vested  in  an  individual,  a  partnership,  or  a 
corporation.  It  is  also  important  for  the  student  to  understand  that 
the  purpose  of  such  a  report  as  that  discussed  in  the  preceding  para- 
graphs of  this  chapter  is  to  present  this  information  in  a  form  which 
makes  it  readily  understandable  and  usable  on  the  part  of  the  manage- 
ment. It  will  be  the  purpose  of  the  following  chapters  to  discuss  more 
in  detail  the  construction  and  interpretation  of  this  statement  of 
assets  and  liabilities  which  in  accounting  is  called  the  balance  sheet. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  Mr.  Brown  lives  in  New  York.    He  owns  a  store  in  Chicago  which  is 
under  the  management  of  Mr.  Smith.    What  information  will  Mr. 
Brown  require  at  the  end  of  the  year  to  judge  the  efficiency  of  the 
management  of  Mr.  Smith  ?    How  will  he  obtain  this  information  ? 

2.  Explain  and  illustrate  the  meaning  of  "asset."     Give  five  assets  which 
the   following   businesses   might    use:    (a)  grocery   store;    (6)  bank; 
(c)  department  store;  (d)  automobile  factory;  (e)  wholesale  jewelry 
house.  • 

3.  J.  H.  King  invests  $10,000.00  in  cash  in  a  retail  store.    He  finds  that 
he  needs  additional  funds  with  which  to  finance  his  business.    How 
may  he  obtain  these  funds  ?    What  effect  will  the  obtaining  of  these 
funds  produce  on  the  financial  condition  of  King  ? 


22  PRINCIPLES  OF  ACCOUNTING 

4.  From  the  records  of  James  Reynolds,  retail  merchant,  the  following 
items  are  copied : 

i.  Land $2,000.00 

a.  Due  from  James  Long 300.00 

3.  Owed  to  John  King 400.00 

4.  Office  furniture 800.00 

5.  Cash 500.00 

6.  Owed  to  bank 1,000.00 

7.  Due  from  W.  E.  Atkins 200.00 

8.  Owed  to  L.  S.  Lyon 300.00 

9.  Merchandise  on  hand 2,500.00 

10.  Owed  to  Reighard  &  Co -.         600.00 

11.  Delivery  equipment 1,200.00 

12.  Buildings 1,300.00 

Classify  these  items  so  as  to  show  which  represent  assets  and  which 
liabilities. 

5.  Arranging  hi  proper  order  the  items  given  in  Question  4,  determine 
the  net  worth  of  proprietorship  of  James  Reynolds. 

6.  If  one  year  later  the  assets  of  Reynolds  have  increased  $3,000.00  and 
his  liabilities  have  increased  $2,000.00,  what  effect  will  this  have  on  his 
proprietorship  ? 

7.  Will  he  regard  this  change  in  proprietorship  as  favorable  or  unfavorable  ? 
What  effect  may  this  change  in  proprietorship  have  on  his  plans  for 
the  next  year  ? 

8.  If  Reync  Ids'  issets  increase $3 ,000.00 and  his  liabilities  increase $4,000.00, 
what  effect  will  this  have  on  his  financial  condition  ?    What  effect  may 
it  have  on  his  plans  for  the  next  year?    What  does  it  indicate  with 
reference  to  the  efficiency  of  the  management  of  Reynolds? 

9.  In  what  different  types  of  business  organization  may  the  proprietorship 
of  a  business  be  vested  ?    State  briefly  the  most  important  charac- 
teristics of  each  from  the  point  of  view  of  business  management. 

10.  In  what  way  does  the  form  of  proprietorship  affect  the  reporting 
requirements  of  the  business  ? 

11.  "The  owner  directly  or  indirectly  exercises  control  of  the  business." 
Can  this  statement  be  justified  in  connection  with  each  type  of 
ownership  ? 

REFERENCES  FOR  FURTHER"  STUDY 

STOCKWELL,  H.  G.,  Net  Worth  and  the  Balance  Sheet,  chap.  i. 

WILDMAN,  JOHN  R.,  Principles  of  Accounting,  chap.  vii. 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  ii  and  iii. 


RELATIONSHIP  OF  ACCOUNTING  TO  PROPRIETORSHIP        23 

LABORATORY  EXERCISE  NO.  1 

\ 
ILLUSTRATION  OF  STATEMENT  SHOWING  PROPRIETORSHIP 

January  i,  1919,  Howard  Reed  entered  the  retail  grocery  business  with 
an  investment  of  $3,550.00  in  cash.  On  December  31,  1919,  he  was  employ- 
ing in  this  business  the  following  property: 

Cash $1,300.00 

Notes  receivable 200.00 

Accounts  due  from  customers: 

A.  B.  Trudeau  .       .  •    \       .       .  $450.00 

J.  F.  Holmes 220.00 

F.  M.  Wright 275.00 

W.  C.  Harvey 125.00 

Total 1,070.00 

Merchandise  inventory 1,075.00 

Furniture  and  fixtures 500.00 

Delivery  equipment 1,500.00 

He  was  indebted  to  trade  creditors  as  follows: 

W.  B.  Smith  &  Co $250.00 

E.  B.  Curtis 400.00 

Wood  Brothers 275.00 

Total $925.00 

The  Citizen's  State  Bank  hold  his  promissory  note  for  $500.00. 
There  have  been  no  withdrawals  of  property  during  the  year. 

Instructions: 

Prepare  a  statement  which  will  show  the  amount  of  Howard  Reed's 
proprietorship  as  of  December  31.  (Show  "Accounts  receivable"  and 
"  Accounts  payable  "  each  as  a  single  item,  omitting  the  detail  of  the  items 
composing  each.) 

What  answer  does  this  statement  give  to  the  foUowing  questions: 

1.  Has  the  original  business  investment  been  maintained? 

2.  Has  a  return  on  the  investment  been  realized,  and  if  so,  what  is  the 
amount  of  such  return  ? 


24  PRINCIPLES  OF  ACCOUNTING 

LABORATORY  EXERCISE  NO.  2 
ILLUSTRATION  OF  STATEMENT  SHOWING  PROPRIETORSHIP 
On  January  i,  1919,  Milton  Jones  invests  $5,500.00  in  the  retail  store 

business.    On  December  31,  1919,  his  assets  and  liabilities  are  as  follows: 

Due  to  bank $2,000.00 

Cash 850.00 

Furniture  and  fixtures       .       .       ...       .       .       .          750.00 

Accounts  payable 1,500.00 

Delivery  equipment 600.00 

Building  and  land 2,000.00 

Merchandise  inventory 3,100.00 

Accounts  receivable    .       . 2,700.00 

Notes  of  customers 200.00 

Instructions: 

Prepare  a  statement  showing  the  proprietorship  of  Jones  as  of  December 

31,  1919. 

Has  the  investment  been  impaired  or  increased  by  the  operations  of 

the  period  ?    What  has  been  the  rate  of  return  on  his  invest  <ent  ? 

LABORATORY  EXERCISE  NO.  3 
ILLUSTRATION  OF  STATEMENT  SHOWING  PROPRIETORSHIP 
The  Jones  Mercantile  Company  is  organized  July  i,  1919,  for  the  pur- 
pose of  conducting  a  small  department  store  with  a  cash  investment  of 
$100,000.00.    On  December  31  of  that  year  the  company  has  the  following 
assets: 

Cash $  5,000.00 

Accounts  receivable    .       .       . 35,000.00 

Notes  receivable 10,000.00 

Merchandise  inventory      . 25,000.00 

Equipment 20,000.00 

Building  and  land .     55,000.00 

The  Company  owes  its  trade  creditors  on  account  $15,000.00  and  has 
notes  payable  outstanding  to  the  amount  of  $20,000.00. 
Instructions: 

Prepare  a  statement  showing  the  total  proprietorship  of  the  Jones 
Mercantile  Company  on  December  31,  1919. 

According  to  this  statement,  what  is  the  proprietorship  on  December 
31  of  a  member  of  the  company  who  contributed  one-tenth  of  the  original 
investment? 


CHAPTER  III 

THE  BALANCE  SHEET 

The  function  of  the  balance  sheet.  In  the  preceding  chapter  some 
consideration  was  given  to  a  simple  form  of  statement  showing  the 
assets,  liabilities,  and  proprietorship  of  a  business  enterprise.  A 
statement  of  this  nature  in  connection  with  any  business  is  known  as 
a  balance  sheet.  From  the  point  of  view  of  the  owner  or  manager, 
the  balance  sheet  serves  two  important  purposes:  (i)  It  enables  him 
to  see  whether  his  original  investment  has  been  maintained  and 
whether  any  additions  have  been  made  thereto.  This  assists  him  to 
evaluate  past  results.  (2)  It  enables  him  to  plan  to  use  his  assets 
and  control  his  liabilities  in  the  future  in  such  a  manner  as  to  increase 
his  proprietorship. 

So  far,  this  form  of  statement  has  been  discussed  only  with  respect 
to  the  information  given  to  the  owner.  The  student  will  recall, 
however,  that  in  the  first  chapter  it  was  pointed  out  that  there  are 
parties  other  than  the  owner  and  his  subordinate  managers  who  have 
an  interest  in  the  business  enterprise  and  that  the  information  fur- 
nished by  the  accountant  must  also  include  information  which  will 
be  useful  to  them  in  forming  judgments  with  respect  to  the  business. 
Those  other  interested  parties,  as  there  indicated,  are:  (i)  the 
creditors  and  prospective  creditors,  both  long  time  and  short  time, 
including  banks,  trade  creditors,  bond  holders,  and  other  holders  of 
long-time  claims;  and  (2)  the  government,  which  may  desire  infor- 
mation to  serve  as  a  guide  in  taxation  or  regulation,  or  both. 

The  balance  sheet  is  the  statement  most  frequently  used  in  fur- 
nishing information  to  interested  parties  outside  the  business,  since 
it  contains  information  which,  if  clearly  set  forth  and  properly  inter- 
preted, is  of  the  greatest  value  to  them.  It  should,  however,  be 
supplemented  by  a  statement  of  the  results  of  current  operations; 
which  will  be  discussed  later.  The  primary  purpose  of  the  balance 
sheet  is  to  aid  the  owner.  However,  the  information  desired  by  the 
owner,  if  it  is  to  be  adequate  to  his  needs,  will  be  sufficiently  inclusive 

25 


26  PRINCIPLES  OF  ACCOUNTING 

to  serve  the  needs  of  the  other  interested  parties  as  well,.  It  is  there- 
fore as  a  report  to  the  owner  that  the  balance  sheet  will  be  considered 
for  the  present. 

The  form  of  the  balance  sheet.  Since  the  purpose  of  the  balance 
sheet  is  to  give  the  owner  the  information  which  he  needs  to  manage 
his  business,  this  information  should  be  given  in  the  most  usable  form. 
The  balance  sheet  shows  three  main  items:  assets,  liabilities,  and 
proprietorship.  The  simplest  form  of  the  balance  sheet,  therefore, 
would  be  one  which  showed  these  in  total. 

If  the  total  assets  of  W.  A.  Williams  are  $9,130,  his  total  liabilities 
$1,500,  and  his  proprietorship  $7,630,  his  balance  sheet  might  be 
made  in  the  following  form: 

Assets $9,130.00 

Liabilities 1,500.00 

Proprietorship $7,630.00 

Such  a  statement  would  give  Williams  information  of  some  value, 
since  by  comparing  it  with  previous  statements  he  could  see  whether 
his  proprietorship  had  increased  or  decreased  and  thereby  judge  the 
success  of  his  business  in  terms  of  profit  and  loss.  However,  he  wants 
more  information  than  this,  since  he  desires  to  know  the  nature  of  his 
assets  and  liabilities,  as  well  as  their  amount.  It  follows  that  the 
assets  and  liabilities  should  be  shown  as  several  items  and  not  merely 
as  totals  only.  In  chapter  ii  it  was  suggested  that  W.  A.  Williams 
might  ascertain  his  proprietorship  by  listing  his  assets  and  liabilities 

as  follows: 

ASSETS 

Cash $1,500.00 

Debts  owing  from  customers    .       .       .  3,040.00 

Merchandise  on  hand        ....  3,500.00 

Furniture  and  fixtures       ....  450.00 

Delivery  equipment 640.00 

Total  assets $9,130.00 

LIABILITIES 

Due  to  merchandise  creditors  .       .       .       $1,500.00        1,500.00 
Proprietorship     .       . $7,630.00 

Such  a  statement  as  this  has  advantages  over  the  form  suggested, 
in  which  only  totals  are  shown.  By  listing  the  different  kinds  of 


THE  BALANCE  SHEET  27 

assets  and  liabilities  separately  the  owner  is  given  information  regard- 
ing the  nature  and  relationships  of  the  various  items  which  would  aid 
him  in  determining  whether  or  not  the  business  is  proceeding  along 
sound  lines,  and  also  in  planning  for  the  future. 

In  listing  the  foregoing  items,  the  terms  employed  in  designating 
the  particular  assets  and  liabilities  are  those  which  might  be  used  by  a 
person  who  does  not  know  the  generally  accepted  terminology  of 
accounting.  There  is  among  the  accounting  fraternity  a  certain 
body  of  terminology  which  is  generally  accepted,  especially  when 
applied  to  the  more  common  kinds  of  assets  and  liabilities.  In  order 
to  see  how  the  terms  in  accounting  would  be  applied  in  a  statement 
containing  the  above  information,  it  is  desirable  to  discuss  separately 
some  of  the  items  appearing  on  the  balance  sheet  of  W.  A.  Williams. 

Debts  owed  by  customers.  The  debts  owed  by  customers  consist 
of  promises  to  pay  which  they  have  given  in  exchange  for  merchandise. 
These  promises  may  be  written  or  they  may  be  oral.  If  a  customer 
gives  his  written  promise  to.  pay  drawn  hi  a  legally  valid  form,  this 
is  known  as  a  note  and  is  classified  under  the  head  of  "  notes  receiv- 
able." If  his  promise  to  pay  is  oral,  or  implied  from  the  fact  that  he 
orders  goods  from  the  business,  he  is  said  to  owe  the  business  on  open 
account  and  the  asset  constituted  by  this  claim  is  classified  as  an 
"account  receivable."  The  claims  of  the  business  against  its  cus- 
tomers are  ordinarily  classified  under  these  two  headings. 

In  the  foregoing  illustration  there  is  listed  as  due  from  customers 
$3,040.  In  a  retail  store  such  as  that  of  W.  A.  Williams,  it  would 
be  quite  unusual  for  written  promises  to  be  given  in  payment  of 
merchandise.  Probably  the  only  conditions  under  which  such  written 
promises  would  be  received  would  be  when  a  customer  failed  to  pay 
his  oral  promises  at  a  specified  time  and  gave  a  written  promise  in 
order  to  obtain  extension  of  time.  Such  customers  would  be  regarded 
as  undesirable  and  therefore  a  large  item  of  notes  receivable  would 
be  looked  upon  with  suspicion.  If  it  is  assumed  in  the  case  of  W.  A. 
Williams  that  he  has  written  promises  to  the  amount  of  $100  and  oral 
promises  of  $2,940,  these  debts  of  his  customers  would  be  listed  on  his 
balance  sheet  as  follows: 

Notes  receivable $    100.00 

Accounts  receivable 2,940.00 


28  PRINCIPLES  OF  ACCOUNTING 

Although  few  written  promises  or  notes,  as  they  are  called  by 
business  men  and  accountants,  are  received  by  retail  stores,  in  some 
lines  of  business  it  is  customary  to  receive  written  promises  in  payment 
of  goods.  A  large  item  of  notes  receivable  on  the  balance  sheet  of 
such  businesses  would  not,  therefore,  be  regarded  as  unfavorable. 
This  will  be  discussed  more  fully  in  a  subsequent  chapter. 

It  is  not  worth  while  at  this  point  for  the  student  to  concern  him- 
self with  the  nature  and  form  of  the  written  promises  discussed  above. 
These  will  be  considered  in  subsequent  chapters.  It  is  sufficient  at 
present  to  know  that  such  written  promises  are  used  in  the  con- 
duct of  a  business;  that  they  are  called  "notes  receivable"  when  in 
favor  of  the  business;  and  that  they  constitute  an  asset  of  the 
business. 

The  oral  promises  to  pay  which  are  received  from  customers  are 
shown  on  the  balance  sheet  as  a  total.  In  the  accounting  records, 
the  amount  due  from  each  customer  is  shown.  It  is  not  desirable, 
however,  to  show  on  the  balance  sheet  the  name  of  each  customer  who 
owes  the  business.  Sometimes  a  list  of  the  customers  and  the  amount 
each  owes  is  attached  to  the  balance  sheet.  The  illustration  on 
page  29  shows  a  list  of  the  creditors  of  W.  A.  Williams.  A  similar 
list  might  be  made  of  the  customers  who  owe  him,  but  such  a  list 
is  usually  omitted  because  of  the  large  number  of  such  customers. 

Merchandise  on  hand.  The  merchandise  on  hand  at  the  time  the 
balance  sheet  is  made  is  known  as  the  merchandise  inventory.  It  is 
usually  obtained  by  making  a  physical  count  of  the  goods  on  hand 
and  determining  their  value  at  cost  price.  If,  however,  the  current 
market  price  is  less  than  cost  price,  the  market  price  should  ordinarily 
be  used  in  determining  their  value.  The  value  of  the  merchandise 
inventory  is  shown  as  an  asset  on  the  balance  sheet. 

Debts  owed  merchandise  creditors.  It  is  explained  above  that 
those  who  purchase  merchandise  from  the  business  may  give  either 
written  or  oral  promises  in  payment.  In  the  same  manner  the  busi- 
ness may  give  either  written  or  oral  promises  in  payment  of  the 
merchandise  purchased  from  others.  The  written  promises  so  given 
are  known  as  "notes  payable"  and  the  oral  promises  as  "accounts 
payable."  In  the  illustration  given,  W.  A.  Williams  owes  creditors 
$1,500  and  it  may  be  assumed  that  $200  of  this  amount  is  represented 
by  written  promises  and  $1,300  is  represented  by  oral  promises, 


THE  BALANCE  SHEET  29 

in  which  case  his  debts  to  creditors  may  be  shown  on  the  balance 
sheet  as  follows: 

ip 

Notes  payable  to  creditors $    200.00          ' 

Accounts  payable 1,300.00 

The  accounts  payable,  like  the  accounts  receivable,  are  shown  on 
the  balance  sheet  as  a  total.  Although  the  accounting  records  show 
the  amount  due  to  each  creditor,  it  is  not  desirable  to  show  the  names 
of  each  creditor  on  the  balance  sheet.  Sometimes  a  list  of  the  credi- 
tors and  the  amount  due  each  is  attached  to  the  balance  sheet.  Such 
a  Ust  of  the  creditors  of  W.  A.  Williams  might  be  as  follows: 

LIST  OF  ACCOUNTS  PAYABLE — DECEMBER  31,  1918 

Chicago  Wholesale  Grocery  Co.       ...  $    300.00 

Quaker  Oats  Co 100.00 

Rollen  Mills  Co 200.00 

E.  C.  Cline  &  Co 400.00 

E.  R.  Taylor  Grocery  Co 180.00 

A.  M.  Anderson  Wholesale  Co.  120.00 


$1,300.00 

The  balance  sheet  with  accounting  terminology.  After  the  foregoing 
discussion  it  is  possible  to  restate  the  assets  and  liabilities  of  W.  A. 
Williams,  using  approved  accounting  terminology  in  describing  them. 
Such  a  statement  would  be  as  follows: 

ASSETS 
Cash     ....."...      $1,500.00 

Notes  receivable 

Accounts  receivable 

Merchandise  inventory      .... 

Office  furniture    ...... 

Delivery  equipment 

Total  assets $9,130.00 

LIABILITIES 

Notes  payable  to  merchandise  creditors  .     $    200.00 
Accounts  payable 1,300.00 

Total  liabilities 1,500.00 


Proprietorship $7,630.00 


36  PRINCIPLES  OF  ACCOUNTING 

Methods  of  determining  the  value  of  certain  assets.  The  balance 
sheet  shows,  among  other  things,  the  value  of  the  assets  in  the  business. 
In  order  that  the  balance  sheet  may  be  of  the  greatest  value  to  the 
owner  as  well  as  to  others  who  may  be  interested  in  the  business,  it 
is  necessary  that  these  values  be  stated  as  accurately  as  possible. 
It  is  from  the  balance  sheet  and  other  such  reports  that  the  infor- 
mation is  obtained  which  serves  as  a  basis  of  judging  past  results  and 
of  making  future  plans.  Judgments  and  plans  based  on  inaccurate 
information  are  dangerous.  The  values  on  the  balance  sheet  should 
therefore  be  stated  accurately. 

To  determine  the  value  of  some  assets  is  quite  easy.  It  is  only 
necessary  to  refer  to  the  accounting  records  and  see  the  values  at 
which  they  are  recorded.  It  can  be  easily  seen  that,  if  all  cash  re- 
ceived by  the  business  is  recorded  in  one  place  and  all  cash  paid  out 
in  another,  the  difference  between  the  totals  recorded  in  the  two 
places  will  give  the  total  of  the  cash  on  hand.  To  obtain  the  amount 
of  the  cash  item  on  the  balance  sheet  is  therefore  a  relatively  easy 
matter.  However,  there  are  some  assets  the  correct  value  of  which 
is  not  shown  in  the  accounting  records  until  certain  adjustments  or 
changes  have  been  made.  It  must  be  ascertained,  therefore,  what 
these  assets  are  and  how  their  value  is  determined. 

It  may  be  assumed  that  W.  A.  Williams  purchased  on  January  i, 
1918,  furniture  and  fixtures  costing  $500  and  delivery  equipment 
costing  $800.  If  Williams  uses  during  the  year  the  furniture  and 
fixtures  which  cost  $500  at  the  beginning  of  the  year,  it  is  evident 
that  they  are  not  worth  $500  at  the  end  of  the  year.  He  may  not 
know  the  exact  amount  they  have  decreased  in  value,  but  he  probably 
knows  from  the  experience  of  himself  and  others  that  such  furniture 
and  fixtures  will  be  worn  out  in  ten  years  and  consequently  he  esti- 
mates that  they  have  decreased  in  value  during  the  first  year  one- 
tenth  of  their  original  value,  or  $50.  This  estimated  decrease  in 
value  of  the  furniture  and  fixtures  may  be  deducted  from  their  cost 
value  of  $500  and  this  asset  will  then  be  listed  on  the  balance  sheet 
as  $450.  Since,  however,  the  $50  represents  only  the  estimated 
decrease  in  value  of  the  asset  and  an  adjustment  may  have  to  be  made 
later,  it  is  thought  by  accountants  and  business  men  to  be  desirable 
to  show  the  original  cost  of  the  asset  with  the  decrease  in  value  sub- 
tracted therefrom.  The  decrease  of  value  of  an  asset  because  of  its 


THE  BALANCE  SHEET  31 

use  in  the  business  is  known  as  depreciation,  therefore  the  $50  allow- 
ance for  the  decrease  in  the  value  of  the  furniture  and  fixtures  might 
be  termed  "an  allowance  for  depreciation."  But,  in  accounting,  such 
estimates  of  the  decrease  in  value  of  fixed  assets  are  known  by  the 
technical  term  of  "reserves."  Therefore  the  allowance  for  depre- 
ciation on  furniture  and  fixtures  may  be  deducted  from  the  asset 
and  may  be  shown  on  the  balance  sheet  as  follows: 

Furniture  and  fixtures       ....         $500.00 
Less  reserve  for  depreciation  of  furniture 

and  fixtures 50.00 

$450.00 

Delivery  equipment  also  decreases  in  value  by  use  in  the  business, 
and  consequently  an  allowance  for  its  depreciation  should  be  shown 
on  the  balance  sheet.  If  Williams  has  delivery  equipment  valued 
at  $800  at  the  beginning  of  the  year  and  he  estimates  that  it  will 
last  for  five  years,  he  should  make  an  allowance  of  $160  each  year 
for  its  depreciation.  Accordingly  at  the  end  of  the  first  year  he  may 
show  the  delivery  equipment  on  the  balance  sheet  at  $640  and  not 
show  the  depreciation  as  a  separate  item.  A  better  method  of  showing 
it,  however,  is  as  follows: 

Delivery  equipment $800.00 

Less  reserve  for  depreciation  of  delivery 
equipment 160.00 

$640.00 

Heading  or  title  of  the  balance  sheet.  The  balance  sheet  is  made  to 
show  the  financial  condition  of  the  firm  at  a  given  date.  It  is  cus- 
tomary, therefore,  to  place  the  name  of  the  firm  and  the  date  of  the 
balance  sheet  as  a  heading  somewhat  as  follows: 

W.  A.  WILLIAMS 

BALANCE  SHEET — DECEMBER  31,  1918 

Sub-titles  of  the  balance  sheet.  The  assets  of  all  mercantile  firms 
can  be  divided  into  at  least  two  classes:  (i)  Those  in  the  form  of 
cash  or  those  which  it  is  anticipated  will  be  converted  into  cash  in 
the  near  future  in  the  regular  operations  of  the  business.  In  account- 
ing, these  are  termed  "current"  assets.  (2)  Those  which  are  used 


32  PRINCIPLES  OF  ACCOUNTING 

rather  more  permanently  in  the  conduct  of  the  business  and  which 
it  is  not  anticipated  will  be  sold  or  turned  into  cash.  In  accounting, 
these  are  called  "fixed"  or  "permanent"  assets. 

By  looking  at  the  balance  sheet  of  W.  A.  Williams  it  will  be  seen 
that  he  has  cash  to  the  amount  of  $1,500;  debts  due  from  customers 
which  he  expects  to  collect  in  the  near  future  to  the  amount  of  $3,040; 
and  merchandise  on  hand  to  the  amount  of  $3,500,  which  he  plans 
to  sell  and  realize  in  cash  within  a  reasonably  short  period  of  time. 
Consequently  he  has  current  assets  to  the  amount  of  $8,040.  In 
addition  he  has  $450  of  office  furniture  and  delivery  equipment  valued 
at  $640.  These  assets  he  expects  to  retain  in  his  business  and  does 
not  expect  to  liquidate  in  cash.  His  fixed  assets,  therefore,  amount  to 
$1,090. 

In  a  similar  manner  the  liabilities  of  a  firm  may  be  divided  into 
two  classes:  (i)  Those  which  the  business  has  promised  to  pay  within 
a  short  tune  after  they  were  incurred,  such  as  debts  due  to  merchan- 
dise creditors  and  to  banks.  These  are  called  "current"  liabilities. 
(2)  Those  which  are  of  long- tune  duration  and  may  not  have  to  be 
paid  until  several  years  after  they  are  incurred.  These  are  known  as 
"fixed"  or  "permanent"  liabilities.  Such  liabilities  will  be  discussed 
in  future  chapters. 

It  will  be  seen  by  the  balance  sheet  of  W.  A.  Williams  that  his 
only  liabilities  are  those  to  merchandise  creditors,  which  amount  to 
$1,500.  According  to  good  business  practice  these  will  be  paid  in 
the  near  future,  so  they  are  current  liabilities.  Williams  has  no 
long-time  obligations,  so  no  fixed  liabilities  are  shown  on  his  balance 
sheet. 

In  addition  to  the  assets  and  liabilities,  the  proprietorship  or  net 
worth  of  the  business  is  shown  on  the  balance  sheet.  This  is  shown 
under  the  separate  heading  or  title  of  "proprietorship,"  "net  worth," 
"capital,"  or  some  similar  term. 

Since  the  purpose  of  the  balance  sheet  is  to  give  as  much  infor- 
mation as  possible  concerning  the  assets  and  liabilities  of  a  business, 
it  is  desirable  to  classify  the  assets  and  liabilities  according  to  their 
nature.  The  method  of  showing  these  classifications  is  illustrated 
in  the  balance  sheet  given  in  the  next  paragraph.  Frequently  sub- 
divisions of  assets  and  liabilities  additional  to  those  discussed  above 


THE  BALANCE  SHEET  33 

are  shown  on  the  balance  sheet,  but  those  given  are  sufficient  for  the 
present  discussion.  The  others  will  be  considered  in  subsequent 
chapters. 

Illustration  of  the  standard  form  of  balance  sheet.  Using  the  items 
and  amounts  previously  given,  a  balance  sheet  may  be  made  for 
W.  A.  Williams,  which  will  comply  with  the  accounting  principles 
discussed  above,  in  the  following  form: 

W.  A.  WILLIAMS 
BALANCE  SHEET — DECEMBER  31,  1918 

ASSETS 

Current  assets: 

Cash $1,500.00 

Notes  receivable 100.00 

Accounts  receivable 2,940.00 

Merchandise  inventory      .       .       .       .  3,500.00 


Total  current  assets .     $8,040.00 

Fixed  assets: 

Office  furniture $500.00 

Less  reserve  for  depreciation    .       .  50.00     $450.00 

Delivery  equipment    ....         800.00 

Less  reserve  for  depreciation    .       .         160.00       640.00 


Total  fixed  assets 1,090.00 

Total  assets $9,130.00 

LIABILITIES 

Current  liabilities: 

Notes  payable  to  merchandise  creditors        $    200.00    «. 
Accounts  payable 1,300.00 


Total  current  liabilities 1,500.00 

PROPRIETORSHIP 

W.  A.  Williams,  proprietor $7,630.00 

A  balance  sheet  such  as  this  one  is  said  to  be  in  the  "report" 
form.  While  this  arrangement  correctly  shows  the  financial  condition 
of  a  business,  accountants  more  frequently  use  the  form  given  below, 
which  is  known  as  the  "account"  form: 


34  PRINCIPLES  OF  ACCOUNTING 

W.  A.  WILLIAMS 

BALANCE  SHEET — DECEMBER  31,  1918 

ASSETS  LIAB I UTIES 
Current  assets:                                       Current  liabilities: 

Cash   .    .    .  $1,500.00  Notes  payable 

Notes  receiv-  to  merchan- 

able  .    .    .      100.00  disc  creditors  $200.00 

Accounts  re-  Accounts  pay- 

ceivable   .    2,940.00  able.    .    .    .   1,300.00 

Merchandise  

inventory.    3,500.00  Total  current 

liabilities $1,500.00 

Total  Cur- 
rent assets     ....  $8,040.00  PROPRIETORSHIP 
Fixed  assets:                                    '       W.  A.  Williams,  proprietor  $7,630.00 
Office  fur- 
niture .  $500.00 
Less  re- 
serve for 
deprecia- 
tion .    .      50.00  $450.00 

Delivery 
equip- 
ment .    .$800.00 
Less  re- 
serve for 
deprecia- 
tion   .    .     160.00  640  oo 


Total  fixed  assets  .    .   1,090.00 

Total  liabilities  and  pro- 
Total  assets  ....  $9,130.00         prietorship $9,130.00 


The  student  will  notice  that  both  these  balance  sheets  show  the 
same  facts.  It  is  only  the  arrangement  that  is  different.  Both  are 
according  to  good  accounting  practice,  but  the  latter  form  is,  at 
present,  used  much  more  frequently  by  accountants  in  their  reports. 
In  the  printed  forms  given  by  banks  to  customers,  on  which  to  report 
their  financial  condition,  the  first  form  is  quite  frequently  called  for 
by  the  arrangement  of  the  items  or  the  printed  blanks.  So  far  as 


THE  BALANCE  SHEET 


35 


the  owner  of  a  business  is  concerned  either  form  serves  his  purpose 
equally  well. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  H.  M.  Friedman,  of  Kansas  City,  Mo.,  desires  to  purchase  on  account 
$i  ,000.00  of  merchandise  from  Carson,  Pirie  &  Scott  of  Chicago.    What 
information  would  Carson,  Pirie  &  Scott  desire  to  obtain  concerning 
H.  M.  Friedman  before  they  ship  the  merchandise  to  him"?    How 
would  they  obtain  this  information  ? 

2.  You  are  working  for  the  First  National  Bank.-  J.  C.  Adams,  retail 
merchant,  requests  the  bank  to  loan  him  $500.00.    The  credit  manager 
of  the  bank  instructs  you  to  investigate  the  financial  condition  of  Mr. 
Adams  and  report  to  him  whether  you  think  the  loan  should  be  granted. 
You  request  Mr.  Adams  to  give  you  a  balance  sheet.     Give  the  items 
which  you  would  expect  to  find  on  the  balance  sheet  of  Mr.  Adams. 

3.  On  the  balance  sheet  of  Mr.  Adams  there  appear  the  following  items: 

Notes  receivable $3,000.00 

Accounts  receivable         ....         1,000.00 

What  might  you  infer  from  the  fact  that  notes  receivable  are  three 
times  as  large  as  accounts  receivable?  Would  you  regard  this  as 
favorable  or  unfavorable  ? 

4.  The  Ford  Motor  Company  produces  automobiles.     It  owns  its  factory, 
machinery,  and  equipment.     The  Jones  Company  is  engaged  in  the  retail 
dry-goods  business.    It  rents  the  building  in  which  its  business  is 
conducted,  but  owns  the  furniture  and  equipment  in  the  store.    In 
what  ways  will  the  balance  sheets  of  these  two  firms  differ  ? 

5.  H.  B.  Johnson,  retail  merchant,  presents  to  his  bank  the  following 
balance  sheet: 


FINANCIAL  STATEMENT — SEPTEMBER  30,  1920 


Bills  receivable  . 
Delivery  equipment  . 
Cash     .... 
Furniture  and  fixtures 
Due  from  customers 
Merchandise 


$   400.00 

800.00 

1,000.00 

600.00 

4,800.00 

5,200.00 

$12,800.00 


Net  worth  . 
Due  to  creditors 
Bills  payable 


$6,800.00 
2,800.00 
3,200.00 


$12,800.00 


Explain  how  this  balance  sheet  should  be  changed  so  as  to  provide  more 
information  and  to  correspond  to  current  accounting  practice. 


36  PRINCIPLES  OF  ACCOUNTING 

6.  R.  E.  Taylor  submits  to  his  bank  in  asking  for  credit  a  balance  sheet 
dated  December  31,  1917.    Upon  examination  it  is  seen  that  no  allow- 
ance has  been  made  for  depreciation  of  fixed  assets.    You  are  instructed 
by  the  credit  manager  of  the  bank  to  make  an  inspection  of  the  records 
of  Taylor  to  determine  the  amount  which  should  be  deducted  on  the 
balance  sheet.    Explain  what  information  you  would  need  in  order  to 
determine  the  amount  of  this  reserve. 

7.  H.  M.  Jones  submits  to  his  bank  a  balance  sheet  made  as  follows: 

H.  M.  JONES 

BALANCE  SHEET — JUNE  30,  1918 

Current  assets  .  .  $15,000.00  Current  liabilities  .  $  7,000.00 
Fixed  assets  .  .  10,000.00  Proprietorship  .  18,000.00 

$25,000.00  $25,000.00 

You  are  asked  by  the  bank  to  explain  to  Mr.  Jones  how  this  balance 
sheet  should  be  revised  so  as  to  give  the  information  which  the  bank 
desires.  What  instructions  would  you  give  to  Mr.  Jones? 

8.  Mr.  Jones  has  a  great  many  customers  who  owe  him.    How  will  the 
amount  which  they  owe  be  shown  on  the  balance  sheet  ?    If  it  is  desired 
to  know  the  name  of  the  individual  customers  and  the  amount  each 
owes,  how  may  this  be  shown  ? 

9.  Explain  and  illustrate  the  difference  between  current  and  fixed  assets; 
between  current  and  fixed  liabilities. 

10.  What  is  the  distinction  between  the  "report"  and  the  "account"  form 
of  the  balance  sheet  ? 

11.  What  should  be  contained  in  the  heading  of  the  balance  sheet  ?    Why  ? 

REFERENCES  FOR  FURTHER  STUDY 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  iv  and  v. 
HATFIELD,  H.  R.,  Modern  Accounting,  chap.  iii. 
STOCKWELL,  H.  G.,  Net  Worth  and  the  Balance  Sheet. 

LABORATORY  EXERCISE  NO.  4 
ILLUSTRATION  OF  THE  BALANCE  SHEET 

C.  A.  Ankromn,  who  is  engaged  in  the  retail  implement  business,  has 
on  January  i,  1919,  the  following  assets  and  liabilities: 

Cash $    800.00 

Notes  receivable  220.00 


THE  BALANCE  SHEET  37 

Accounts  due  from  customers: 

O.  T.  Gooch $100.00 

John  K.  Dew 55-°° 

W.  E.  Hampton 50.00 

R.  E.  Taylor      ........  75.00 

D.  D.  Dwyer     .       . 120.00 

H.  L.  Cohagen 250.00 

Merchandise  inventory 2,000.00 

Furniture  and  fixtures 75-°o 

Delivery  equipment 125.00 

Due  to  the  Continental  Trust  Co 300.00 

Due  to  creditors,  as  follows: 

H.  M.  Gooch 120.00 

A.  M.  Joesting 150.00 

James  M.  Monroe 180.00 

A.  M.  Chapman,  who  is  conducting  a  rival  business,  has  entered  into  a 
partnership  agreement  with  C.  A.  Ankromn  on  the  above  date  and  invests 
the  following  assets  and  liabilities: 

Cash $1,000.00 

Notes  receivable 300.00 

Accounts  due  from  customers: 

E.  H.  Wagner 100.00 

•     Chas.  R.  Rigg 200.00 

T.  M.  Hamlet 150.00 

A.  R.  Manley 75.00 

G.  B.  Crawford 125.00 

M.  A.  McBride 85.00 

Merchandise  inventory 1,500.00 

Delivery  equipment 800.00 

Furniture  and  fixtures     ..*....  600.00 

He  owes  notes  payable 400.00 

Due  to  creditors: 

James  Gleason 7S-°° 

G.  L.  Logan 125.00 

Instructions: 

Prepare  a  balance  sheet,  showing  the  net  worth  of  Ankromn  before 
consolidation  with  Chapman.  Show  assets  and  liabilities  properly  classi- 
fied. Show  accounts  receivable  and  payable  as  totals. 

Prepare  a  similar  statement  showing  the  net  worth  of  the  firm  of  Chap- 
man on  the  above  date. 

Prepare  a  balance  sheet  for  the  partnership  of  Ankromn  &  Chapman, 
giving  the  interests  of  each  partner  in  the  new  firm. 


38  PRINCIPLES  OF  ACCOUNTING 

LABORATORY  EXERCISE  NO.  5 
ILLUSTRATION  OF  THE  BALANCE  SHEET 

On  December  31, 1919,  the  records  of  Ankromn  &  Chapman  provide  the 
following  information: 

Cash  on  hand $3,000.00 

Accounts  receivable  have  increased       ....         2,800.00 
Merchandise  inventory  has  increased    ....  800.00 

Delivery  equipment,  purchased  on  July  i,  1919         .  300.00 

Furniture  and  fixtures,  purchased  on  October  i         .  100.00 

Notes  received  from  customers  during  the  year  .       .        1,200.00 
Notes  paid  by  customers  during  the  year    .       .       .  800.00 

Merchandise  purchased  on  account       ....       20,800.00 
Paid  to  creditors  to  apply  on  account  ....       18,200.00 

Notes  issued  to  bank  and  unpaid 1,200.00 

Paid  on  notes  due  to  bank 300.00 

Notes  issued  to  creditors  have  increased      .       .       .  400.00 

It  is  estimated  that  the  yearly  depreciation  on  furniture  and  fixtures 
and  on  delivery  equipment  is  10  per  cent. 
Instructions: 

Prepare  a  balance  sheet  for  Ankromn  &  Chapman  as  of  December  3 1 , 
1919.  Profits  and  losses  are  shared  by  Ankromn  and  Chapman  in  pro- 
portion to  their  original  investment. 

Show  accounts  receivable  and  payable  as  totals  and  show  the  assets 
and  liabilities  properly  classified. 

LABORATORY  EXERCISE  NO.  6 

Copy  Ankromn  &  Chapman's  balance  sheet  as  of  December  31,  1919. 
Write  opposite  each  item  the  figure  at  which  such  item  stood  as  at  Janu- 
ary i,  1919,  when  the  partnership  was  formed. 

This  constitutes  one  form  of  the  "comparative"  balance  sheet.  State 
briefly  what  value  you  think  such  a  report  might  have. 


CHAPTER  IV 

THE  STATEMENT  OF  PROFIT  AND  LOSS 

Statement  of  profit  and  loss  needed  to  supplement  balance  sheet.  It 
has  been  explained  that  the  owner  of  property  uses  it  in  conducting 
a  business  with  the  expectation  of  making  a  profit.  It  has  also  been 
explained  that  the  owner  of  property  expects  the  accounting  records 
to  provide  him  information  which  will  show  him,  first,  whether  a 
profit  is  being  made  and,  if  so,  the  amount  thereof;  second,  how  he  can 
plan  to  use  his  property  in  the  future  so  as  to  increase  his  profits. 
In  order  to  give  this  information  to  the  owner  so  that  it  can  be  easily 
understood  and  used,  certain  reports  or  statements  are  used.  These 
reports  show  in  summarized  and  classified  form  the  information 
which  the  accounting  records  contain. 

One  form  of  report  which  is  in  common  use  was  discussed  in  the 
preceding  chapter.  The  balance  sheet,  a  conventional  form  of  which 
was  there  illustrated  and  discussed,  supplies  information  with  respect 
to  the  nature  and  amount  of  the  assets  and  liabilities  and  the  amount 
of  the  resulting  proprietorship.  Also  by  comparing  a  balance  sheet 
at  the  end  of  a  given  period  with  the  balance  sheet  for  the  same  business 
at  the  end  of  the  preceding  period,  the  owner  may  ascertain  readily 
the  amount  of  the  increase  or  decrease  in  proprietorship.  Moreover, 
he  can  tell  what  changes  in  assets  and  liabilities  have  resulted  in  such 
increase  or  decrease.  The  balance  sheet  does  not,  however,  furnish 
any  appreciable  amount  of  information  with  respect  to  the  nature  or 
volume  of  the  business  operations  that  have  brought  about  these 
changes  in  the  assets  and  liabilities,  and  consequently  falls  far  short 
of  supplying  the  owner  with  the  information  necessary  for  estimating 
and  providing  for  the  operations  of  the  coniing  period.  An  illustration 
will  make  this  apparent. 

The  balance  sheet  of  W.  A.  Williams  of  December  31,  1918,  as 
given  hi  chapter  iii,  shows  his  net  worth  or  proprietorship  to  be  $7,630. 
If  a  year  before  his  balance  sheet  showed  his  net  worth  to  be  $6,500, 
his  proprietorship  has  increased  $1,130.  Consequently,  if  he  had  not 

39 


40  PRINCIPLES  OF  ACCOUNTING 

withdrawn  anything  during  the  year  or  made  any  additional  invest- 
ment, he  would  assume  that  he  had  made  a  profit  of  $1,130.  Although 
such  an  ascertainment  of  profits  by  the  comparison  of  the  proprietor- 
ship at  the  end  of  the  period  with  that  at  the  end  of  the  preceding 
period  shows  the  proprietor  the  amount  of  the  profits  earned,  it  does 
not  show  the  cause  of  the  profit.  A  year  later  when  Williams  makes 
his  balance  sheet  on  December  31,  1919,  he  may  find  that  his 
proprietorship  has  increased  only  $800;  therefore  his  profits  are 
$430  less  than  they  were  the  year  before.  His  balance  sheet, 
however,  will  not  show  why  his  profits  are  smaller  than  for  the  year 
before. 

It  may  be  that  his  sales  for  the  year  have  been  smaller  or  that  the 
cost  of  the  goods  purchased  has  been  more,  or  it  may  be  that  more 
has  been  paid  for  clerk  hire,  heat,  light,  and  other  expenses.  He  of 
course  wishes  to  plan  his  business  for  the  next  year  so  as  to  remedy,  if 
possible,  the  difficulty  of  the  past  year. 

It  is  evident,  then,  that  some  sort  of  supplementary  report  should 
be  prepared  to  enable  the  owner  to  understand  the  nature  of  past 
operations  sufficiently  well  to  plan  future  operations.  Such  a  report 
should  show  the  amount  of  the  sales  for  the  period,  the  cost  of  the 
goods  sold,  the  expenses  involved  in  selling  them,  such  as  advertising, 
clerk  hire,  and  the  like,  as  well  as  all  the  other  expenses  necessary 
for  carrying  on  the  business,  such  as  heat,  light,  insurance,  deprecia- 
tion on  the  different  assets  employed,  expenses  in  delivering  the  goods, 
expenses  of  accounting,  and  any  other  expenses  involved  in  the 
administration  of  the  business.  The  same  considerations  hold  good 
whether  the  final  results  of  the  year's  operations  show  a  profit  or  a 
loss.  If  it  is  a  profit,  it  will  enable  him  to  plan  his  business  so  as  to 
continue  on  an  equally  profitable  basis  or  an  even  more  profitable 
one  if  possible.  If  a  loss,  he  will  wish  to  discover  the  difficulty,  and 
to  plan  the  next  year's  operations  in  such  a  way  as  to  obviate  the 
reason  for  such  a  loss  and  to  convert  the  loss  into  a  profit. 

A  report  which  embodies 'this  information  is  one  which  is  usually 
prepared  at  the  end  of  the  accounting  period  at  the  same  time  as  the 
balance  sheet,  and  is  known  as  the  statement  of  profit  and  loss.  This 
report  is  a  very  important  one.  Used  in  connection  with  the  balance 
sheet,  it  supplies  valuable  information  concerning  the  nature  of  the 
operations  of  the  past  period,  and  the  profit  or  loss  which  has  resulted 


from  these  operations.  The  two  reports,  considered  together,  are 
very  useful  as  an  aid  in  planning  future  operations. 

There  are  many  other  reports  which  aid  in  the  proper  conduct 
of  the  business,  and  these  will  be  considered  in  detail  later.  The 
balance  sheet  and  the  statement  of  profit  and  loss,  however,  are  the 
two  which  are  indispensable  in  practically  every  business  and  which 
are  prepared  and  used  more  commonly  than  any  of  the  others. 

Form  of  the  statement  of  profit  and  loss.  The  statement  of  profit 
and  loss,  as  well  as  the  other  forms  of  reports  prepared  for  the  use  of 
the  owner,  should  be  put  into  the  form  which  makes  readily  available 
for  his  use  the  information  which  he  needs  to  have.  In  an  earlier 
paragraph  some  of  the  items  of  information  which  should  be  contained 
in  the  statement  of  profit  and  loss  were  suggested,  but  this  was  done 
without  grouping  them  in  the  most  logical  way.  The  statement 
of  profit  and  loss  shows  four  principal  items:  (i)  the  amount  of  the 
sales  made  for  the  period;  (2)  the  cost  of  the  goods  sold;  (3)  the 
total  expenses  of  conducting  the  business;  (4)  the  resulting  net  profit 
for  the  period.  As  was  suggested  in  the  case  of  the  balance  sheet, 
the  very  simplest  form  of  such  a  statement  would  be  one  which  shows 
these  items  as  totals  only. 

If  W.  A.  Williams  has  made  sales  amounting  to  $24,000  during 
the  year,  and  the  cost  of  the  goods  sold  is  $17,000,  and  the  expenses 
incurred  in  conducting  the  business  are  $6,000,  with  a  resulting  net 
profit  of  $1,000,  the  statement  of  profit  and  loss  might  be  made  in  the 
following  form: 

Sales  for  the  year    .       .       .      $24,000.00 
Cost  of  goods  sold  .       .       .        17.000.00 


Gross  profit $7,000.00 

Expenses 6,000.00 

Net  profit $1,000.00 

Such  a  statement  would  be  of  some  value  to  Williams  if  studied 
by  itself  and  would  be  of  even  more  value  if  compared  with  previous 
statements.  By  such  a  comparison  he  could  see  not  only  the  increase 
or  decrease  in  the  net  profit,  but  also  whether  his  sales  have  increased 
or  decreased  and  whether  the  cost  of  goods  sold  and  the  expenses  of 
conducting  a  business  have  increased  faster  than  sales.  If  profits 


42  PRINCIPLES  OF  ACCOUNTING 

have  increased  or  decreased,  this  may  be  the  result  of  any  one  of 
several  combinations  of  circumstances.  Take  for  illustration  an 
increase  of  profits  over  a  preceding  year.  This  may  result  from: 
(i)  an  increase  in  the  volume  of  sales  with  the  ratios  among  the  four 
items  listed  remaining  substantially  the  same;  (2)  a  lower  cost  of 
goods  sold  without  any  increase  in  sales  or  any  appreciable  increase 
in  the  expenses  of  the  business;  (3)  an  increase  in  sales  with  a  larger 
proportionate  increase  in  the  cost  of  goods  sold,  expenses,  or  both, 
still  resulting  in  an  increased  profit;  (4)  a  decrease  in  the  sales  with 
more  than  a  proportionate  decrease  in  cost  of  goods,  expenses,  or  both. 

These  are  merely  suggestions  of  some  of  the  different  combinations 
that  might  appear.  A  decrease  in  the  net  profits  might  result  from 
an  equally  large  number  of  changes  in  the  relationships  of  these  four 
principal  items.  A  knowledge  of  these  facts,  as  the  student  will 
readily  understand,  must  be  of  considerable  assistance  to  the  owner  in 
planning  his  business  by  indicating  to  him  which  of  these  four  main 
groups  should  receive  especial  attention  in  an  effort  to  modify  the 
relations  among  them  so  as  to  result  in  a  larger  net  profit.  Thus  the 
manager  may  decide  that  the  expenses  are  too  large  and  that  he  should 
make  an  effort  either  to  reduce  them  or  to  increase  the  volume  of 
sales  without  increasing  expenses  appreciably.  But  at  this  point  a 
difficulty  arises.  If  there  is  available  no  more  information  than  is 
furnished  by  this  brief  summary,  how  can  an  owner  determine  what 
is  the  best  way  to  go  about  changing  this  ratio  ?  How  is  he  to  know 
that  a  decrease  in  expenses  is  possible  without  seriously  crippling  the 
efficiency  of  the  business  operations  ?  How  is  he  to  estimate  whether 
an  increase  of  sales  under  the  conditions  prevailing  is  not  likely  to 
cause  even  a  greater  proportional  increase  in  expenses?  And  if 
expenses  are  to  be  reduced,  where  should  that  reduction  fall  ?  Shall 
it  be  in  the  expense  of  advertising,  in  the  number  or  rate  of  remumera- 
tion  of  the  sales  force,  in  expenses  of  delivery,  or  in  the  office  ex- 
penses? The  information  made  available  by  so  simple  a  statement 
is  not  adequate  for  the  solution  of  such  problems  as  these. 

It  is  plain  that  there  must  be  a  somewhat  fuller  analysis  of  the 
main  groups  of  the  statement  of  profit  and  loss.  For  each  of  these 
groups  such  analysis  must  be  shown  as  will  give  the  owner  a  basis  for 
intelligent  planning.  The  four  groups  shown  above  may  be  considered 
one  by  one  to  determine  what  analysis  of  each  is  desirable. 


THE  STATEMENT  OF  PROFIT  AND  LOSS  43 

Sales.  It  may  be  assumed  that  in  a  small  business  such  as  is 
conducted  by  Mr.  Williams  the  total  sales  may  be  considered  as  one 
item.  In  many  businesses  it  is  desirable  to  provide  an  analysis  of 
sales  in  the  accounts  and  on  the  reports.  In  later  chapters  some  of 
the  analyses  which  may  be  of  value  will  be  considered.  For  the 
present,  however,  it  will  be  assumed  for  the  sake  of  simplicity  that  an 
analysis  of  sales  is  not  necessary.  Accordingly  the  sales  of  Mr. 
Williams  will  be  shown  on  the  statement  of  profit  and  loss  as  a  total 
of  $24,000. 

Cost  of  goods  sold.  The  cost  of  goods  sold  is  obtained  by  a  com- 
bination of  at  least  three  items,  and  it  is  customary  to  show  these 
separately  on  the  profit  and  loss  statement.  Assuming  that  Mr. 
Williams  is  conducting  a  mercantile  business,  and  not  manufacturing 
any  of  the  goods  he  sells,  if  he  had  $2,500  of  merchandise  on  hand  at 
the  beginning  of  the  year  and  purchased  $18,000  of  merchandise 
during  the  year  he  should  have  $20,500  of  merchandise  on  hand  on 
December  31  if  none  had  been  sold.  But  he  has  been  selling  through- 
out the  year,  and  on  December  31,  by  actual  count,  he  finds  that  he 
has  $3,500  of  merchandise  on  hand.  He  assumes  that  the  goods  not 
on  hand  must  have  been  sold;  and  consequently  by  substracting 
$3,500,  the  amount  of  goods  on  hand  December  31,  from  $20,500,  the 
amount  of  goods  on  hand  January  i  plus  the  purchases  made  during 
the  year,  he  obtains  a  difference  of  $17,000,  which  represents  the 
cost  of  the  goods  sold  during  the  year. 

As  previously  stated,  the  goods  in  which  a  mercantile  business 
deals  are  known  as  merchandise  and  the  amount  on  hand  at  any 
particular  time  is  known  as  the  merchandise  inventory.  In  view  of 
the  foregoing,  it  may  be  understood  quite  easily  why  the  cost  of 
goods  sold  is  shown  on  the  statement  of  profit  and  loss  as  follows: 

COST  OF  GOODS  SOLD 

Merchandise  inventory,  Janu-  • 

ary  i,  1918         ...       $  2,500.00 
Purchases       ....         18,000.00 


$20,500.00 

Merchandise  inventory,  De- 
cember 31,  1918      3,500.00 

Net  cost  of  goods  sold $17,000.00 


44  PRINCIPLES  OF  ACCOUNTING 

Gross  profit  on  sales.  When  the  cost  of  goods  sold  is  subtracted 
from  sales,  the  difference  represents  the  profit  which  would  be  made 
if  no  expenses  were  incurred  in  conducting  the  business.  Expenses 
are  always  incurred,  however,  in  the  sale  of  goods;  therefore,  it  is 
necessary  to  consider  them  in  determining  the  profit  made.  Conse- 
quently the  difference  between  the  amount  received  from  sales  and 
the  cost  of  goods  sold  is  termed  "gross  profit  on  sales."  It  is  termed 
"gross"  profit  because  the  expenses  must  be  subtracted  hi  order  to 
obtain  the  final  or  "net"  profit. 

W.  A.  Williams  has  made  sales  to  the  amount  of  $24,000  and  the 
cost  of  goods  sold  is  $17,000,  so  the  gross  profit  on  sales  is  $7,000. 
It  appears  on  the  statement  of  profit  and  loss  as  shown  in  the  illus- 
tration of  this  statement  at  the  end  of  the  chapter. 

Classification  of  expenses.  On  page  41  the  expenses  of  W.  A. 
Williams  are  shown  as  one  item  of  $6,000.  Although  all  the  expenses 
of  a  business  may  be  shown  as  one  total,  it  is  desirable  that  expenses 
be  classified.  The  nature  and  amount  of  the  operating  expenses  are 
determined  by  the  size,  nature,  and  organization  of  the  business. 
In  a  mercantile  business,  since  the  principal  operations  are  in  con- 
nection with  the  purchase  and  sale  of  merchandise,  it  will  be  apparent 
that  the  expenses  incurred  hi  connection  with  buying,  usually  known 
as  "buying  expenses,"  and  those  incurred  in  connection  with  sales, 
known  as  "selling  expenses,"  are  two  principal  items.  In  addition 
to  these,  certain  expenses  known  as  "administrative  expenses"  are 
incurred  in  the  general  administration  of  the  business^  In  a  retail 
business  where  goods  are  delivered  to  the  customers  there  is  another 
item  of  expense  known  as  "delivery  expense."  This  item  also  occurs 
in  connection  with  a  wholesale  business,  since  it  is  necessary  to  deliver 
to  the  railroad  station  the  goods  sold.  In  connection  with  a  wholesale 
business  it  is  sometimes  called  "drayage"  instead  of  delivery  expense. 
In  a  business  where  large  stocks  are  carried  and  as  a  consequence  a 
large  warehouse  maintained,  the  item  of  "warehouse  expense"  will  be 
found.  In  a  manufacturing  business  certain  expenses  known  as 
"manufacturing  expenses"  will  be  incurred  in  connection  with  the 
manufacturing  operations.  In  other  lines  of  business  where  other 
operations  are  performed  other  items  of  operating  expense  will  occur. 
In  the  present  discussion  of  the  statement  of  profit  and  loss  only  the 
first  four  items  mentioned,  that  is,  buying,  selling,  delivery,  and 


THE  STATEMENT  OF  PROFIT  AND  LOSS  45 

administrative  expenses,  will  be  considered.     In  later  chapters  other 
kinds  of  expense  will  be  considered. 

The  expenses  incurred  in  connection  with  any  one  of  these  opera- 
tions of  the  business — buying,  selling,  delivering,  and  administering — 
may  be  shown  under  several  heads  so  as  to  indicate  its  particular 
nature.  For  the  sake  of  brevity  and  simplicity  it  will  be  assumed  for 
the  present  that  all  the  expense  in  reference  to  each  operation  is 
recorded  in  one  account  and  shown  as  one  item  on  the  statement  of 
profit  and  loss.  If  kept  hi  separate  accounts  these  would  be  shown 
on  the  statement  under  the  main  headings  suggested  above.  For 
instance,  the  selling  expenses  might  be  shown  as  follows: 

SELLING  EXPENSES 

Salaries  and  wages  of  sales  force      .       .  $900.00 

Advertising 500.00 

Miscellaneous      .       .       .       .       .       .  40.00 

Total  selling  expense $1,440.00 

If  only  the  four  accounts  mentioned  above  are  kept  with  operating 
expenses,  they  will  be  shown  on  the  statement  of  profit  and  loss  as 
follows: 

Buying  expenses 

Selling  expenses 

Delivery  expenses 

Administrative  expenses    .... 

Total  operating  expenses $6,000.00 

In  a  subsequent  chapter  the  particular  items  which  may  con- 
stitute the  buying,  selling,  delivery,  and  administrative  expenses 
will  be  indicated  in  connection  with  the  construction  and  interpre- 
tation of  the  accounts  kept  with  these  expenses. 

Operating  and  non-operating  expenses.  In  the  conduct  of  a  busi- 
ness the  owner  incurs  certain  expenses  which  are  the  result  of  the 
regular  operations  of  the  business.  These  are  known  as  "operating 
expenses."  All  those  already  mentioned  under  the  headings  of  selling, 
buying,  delivery,  and  administrative  expenses  are  of  this  type.  In 
addition,  the  owner  may  incur  certain  other  expenses  which  are  not  con- 
nected directly  with  the  primary  operations  of  the  business  and  which 
are  known  as  non-operating  expenses.  For  example,  W.  A.  Williams 


46  PRINCIPLES  OF  ACCOUNTING 

may  purchase  a  garage  which  he  retains  for  a  time  and  sells  for  a 
profit.  The  profit  arising  from  this  transaction  does  not  arise  from 
the  regular  operations  of  the  business,  since  it  is  not  the  function  of  a 
retail  merchandise  store  to  deal  in  garages.  Consequently  this  profit 
is  termed  "non-operating  income."  It  is  probable  that  some  expenses 
will  be  incurred  in  connection  with  the  garage  before  it  is  sold.  These 
expenses,  if  they  are  not  incurred  in  connection  with  the  regular 
operations  of  the  business,  will  be  termed  "non-operating  expenses." 
It  is  quite  usual  to  find  in  connection  with  a  business  enterprise 
certain  income  and  also  certain  expenses  which  fall  outside  the  line 
of  operations  for  which  the  business  is  organized.  It  is,  therefore, 
the  practice  on  the  statement  of  profit  and  loss  to  distinguish  between 
operating  and  non-operating  income  and  expenses. 

For  the  present  such  non-operating  expenses  can  be  disregarded 
for  they  would  not  be  of  frequent  occurrence  in  the  case  of  a  small 
business  like  that  of  W.  A.  Williams.  Later  they  will  be  discussed 
and  the  method  of  showing  them  on  the  statement  of  profit  and  loss 
will  be  illustrated.  The  purpose  of  mentioning  them  here  is  to  point 
out  to  the  student  that  such  expenses  are  not  included  hi  the  oper- 
ating expenses  of  a  business  and  to  explain  that  the  operating  expenses 
of  a  business  are  usually  indicated  as  such  on  the  statement  of  profit 
and  loss  as  follows: 

OPERATING  EXPENSES 

Buying  expenses $   444.00 

Selling  expenses 1,440.00 

Delivery  expenses 750.00 

Administrative  expenses    ....        3,366.00 

Total  operating  expenses $6,000.00 

Heading  or  title  of  the  statement  of  profit  and  loss.  A  discussion  of 
the  form  of  the  statement  of  profit  and  loss  would  not  be  complete 
without  some  mention  of  the  form  of  heading.  This  statement  is 
drawn  up  to  show  certain  facts  with  regard  to  a  particular  business.  It 
follows  that,  as  in  the  case  of  the  balance  sheet,  it  is  essential  that  the 
name  of  the  business  should  appear  prominently  hi  the  heading.  The 
balance  sheet  represents  the  condition  of  the  business  enterprise  as  at 
a  given  date  and  consequently  it  gives  the  name  of  the  company  and 
the  date.  The  statement  of  profit  and  loss,  however,  does  not  give 


THE  STATEMENT  OF  PROFIT  AND  LOSS  47 

the  condition  of  the  business  upon  a  given  date,  but  gives  a  summary 
of  the  operations  of  the  business  for  a  given  period,  which  may  be  of 
any  duration,  say,  a  year,  or  a  month.  In  the  heading  of  the  state- 
ment of  profit  and  loss,  therefore,  there  will  be  shown  the  length  of 
the  period  covered,  whether  a  month,  three  months,  six  months,  or  a 
year;  and  the  date  at  which  the  period  ends.  On  the  statement  of 
profit  and  loss  for  Mr.  Williams  the  heading  will  appear  as  follows: 

W.  A.  WILLIAMS 
STATEMENT  OF  PROFIT  AND  Loss  FOR  YEAR  ENDING  DECEMBER  31,  1918 

Illustration  of  the  conventional  form  of  the  statement  of  profit  and  loss. 
Having  now  discussed  the  main  points  to  be  considered  in  preparing 
the  profit  and  loss  statement,  and  having  undertaken  some  analysis 
of  the  main  groups  into  which  such  a  report  would  be  divided,  as  well 
as  the  proper  form  of  heading,  it  is  possible  to  assemble  these  groups 
into  a  form  which  will  illustrate  in  a  simple  way  the  essentials  of  the 
statement.  Using  the  items  and  the  amounts  previously  assumed, 
the  report  will  appear : 

W.  A.  WILLIAMS 

"TATEMENT  OF  PROFIT  AND  Loss  FOR  YEAR  ENDING  DECEMBER  31,  1918 

Sales $24,000.00 

Cost  of  goods  sold: 

Merchandise   inventory, 

January  i,  1918    .       $  2,500.00 

Purchases     .       .       .         18,000.00    $20,500.00 


Merchandise    inventory, 

December  31,  1918     .       .       .        3,500.00 

Cost  of  goods  sold 17,000.00 

Gross  profit  on  sales $7,000.00 

Operating  expenses: 

Buying  expense  .  .  $  444.00 
Selling  expense  .  .  1,440.00 
Delivery  expense  .  750.00 

Administrative  expense        3,366.00 

Total  operating  expenses  .       .      $6,000.00 

Net  profit $1,000.00 


48  PRINCIPLES  OF  ACCOUNTING 

This  form  of  the  statement  of  profit  and  loss  resembles  closely  the 
first  form  of  balance  sheet  shown  on  page  33,  and,  like  it,  is  known  as 
the  "  report "  form.  The  statement  of  profit  and  loss  is  also  sometimes 
drawn  in  the  "account"  form,  but  this  form  is  now  almost  entirely 
obsolete  in  general  practice.  It  hardly  seems  worth  while  to  illustrate 
it  here.1  Illustrations  may  be  found  in  some  of  the  older  texts  if 
the  student  wishes  to  see  how  such  a  statement  might  be  shown  in  the 
account  form.  The  form  shown  above  is  the  logical  one  and  is  the 
one  generally  employed  by  accountants.  The  student  should  famil- 
iarize himself  with  it  and  be  sure  that  he  has  a  grasp  of  the  principles 
underlying  its  organization. 

Balance  sheet  and  statement  of  profit  and  loss  taken  as  types  oj 
reports.  It  has  been  repeatedly  emphasized  that  the  purpose  of 
accounting  is  to  provide  reports  which  will  be  of  aid  to  the  manage- 
ment in  the  conduct  of  the  business.  Two  examples  of  such  reports 
have  been  shown  and  some  reasons  for  their  preparation  presented. 
The  balance  sheet  and  the  profit  and  loss  statement  have  been  se- 
lected as  typical  of  reports  in  general  because  they  are  the  two  forms 
which  are  at  present  jn  practically  universal  use.  Employed  in  con- 
junction with  each  other,  these  two  reports  supply  much  valuable 
information.  When  complete  and  carefully  prepared  they  present 
information  that  is  significant  not  only  to  the  owner  but  also  to  the 
creditors,  both  long-time  and  short-time,  and  to  governmental 
agencies  for  taxation  and  regulation,  as  well.  However,  they  fall  far 
short  of  supplying  all  the  analysis  needed  in  the  internal  management 
of  the  business.  There  are  a  number  of  other  forms  of  reports  which 
are  desirable,  and  which  are  actually  being  used  by  the  more  pro- 
gressive business  organizations. 

It  is  scarcely  worth  while  to  present  any  of  the  more  complicated 
forms  for  the  consideration  of  the  student  at  this  point.  It  is  quite 
enough  for  the  present  if  he  can  be  made  to  understand  the  principles 
involved  in  the  preparation  of  the  reports  needed  by  a  very  simple 
form  of  business  organization.  A  clear  understanding  of  the  con- 
struction, interpretation,  and  use  of -the  accounting  records  necessary 
to  serve  the  reporting  requirements  of  such  a  business  is  a  considerable 
attainment  for  the  beginning  student.  When  he  has  once  mastered 

'See  Klein,  J.  J.,  Elements  of  Accounting,  p.  172,  for  an  illustration  of  the 
profit  and  loss  statement  in  account  form. 


THE  STATEMENT  OF  PROFIT  AND  LOSS  49 

the  fundamentals  of  accounting,  with  simple  applications,  it  should 
not  be  difficult  to  extend  the  application  of  these  principles  to  more 
complicated  business  organizations,  with  more  extensive  reporting 
requirements. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  Mr.  Jones  has  three  stores  located  in  Chicago.    He  has  a  manager  for 
each  store.    What  information  must  he  have  in  order  to  determine 
the  comparative  efficiency  of  these  managers  ?    How  would  he  obtain 
this  information  ? 

2.  What  are  the  principal  items  of  information  shown  on  the  statement 
of  profit  and  loss  ? 

3.  What  would  be  the  first  item  shown  on  the  statement  of  profit  and  loss 
of  the  following  businesses:   (a)  grocery  store;  (b)  bank;  (c)  firm  of 
lawyers;   (d)  commission  house;   (e)  railroad;   (/)  department  store; 
(g)  shoe  factory. 

4.  G.  E.  Frazer  had  merchandise  on  hand  on  March  i  to  the  value  of 
$4,000.00.    During  the  month  he  purchased  $8,000.00  of  merchandise 
and  sold  $10,000.00.    On  March  31   his  inventory  was  valued  at 
$4,200.00.    His  expenses  for  the  month  had  been  $1,000.00.    What 
was  his  net  profit  for  the  month  ? 

5.  At  the  end  of  the  next  month  the  statement  of  profit  and  loss  of  Frazer 
shows  that  he  has  made  a  profit  of  only  $600.00.    He  is  puzzled  as  to 
the  cause  of  the  decrease  and  asks  your  advice.    In  looking  over  his 
records  you  find  that  $800.00  lost  in  trading  on  the  Stock  Exchange 
has  been  added  to  his  expenses  for  the  month.    What  report  would 
you  make  to  him  ? 

6.  Explain  and  illustrate  the  difference  between  "gross"  and  "net"  profit. 

7.  On  the  statement  of  profit  and  loss  of  the  X  Retail  Store  the  operating 
expenses  are  listed  as  follows : 

OPERATING  EXPENSES 

Salaries 

Rent 

Light *  .  

Heat 

Taxes 

Depreciation 

Repairs 

Supplies          .       . 

Traveling  expenses 

Insurance       

Is  this  a  satisfactory  classification  of  expense  ?    Why  ? 


SO  PRINCIPLES  OF  ACCOUNTING 

8.  On  December  31,  1919,  the  statement  of  profit  and  loss  of  W.  T.  Hupe 
in  summary  form  is  as  follows: 

Sales  for  the  year $36,000.00 

Cost  of  goods  sold  .       .   - 20,000.00 

Gross  profit  on  sales $16,000.00 

Operating  expenses 12,000.00 

Net  operating  profit $  4,000.00 

One  year  later  the  statement  of  profit  and  loss  of  Hupe  is  as  follows: 

Sales  for  the  year $72,000.00 

Cost  of  goods  sold 44,000.00 

Gross  profit  on  sales $28,000.00 

Operating  expenses 27,000.00 


Net  operating  profit  $  1,000.00 

Mr.  Hupe  is  surprised  to  find  that  though  his  sales  have  doubled,  his 
profits  have  decreased.  He  asks  you  for  an  explanation.  What 
explanation  would  you  give  him  ? 

9.  Give  some  of  the  probable  reasons  for  the  unfavorable  results  obtained 
by  Mr.  Hupe  during  the  year  1920. 

10.  Explain  and  illustrate  the  difference  between  operating  and  non- 
operating  expenses;  operating  and  non-operating  income. 

n.  Explain  and  illustrate  the  difference  between  an  "expense"  and  an 
"expenditure." 

REFERENCES  FOR  FURTHER  STUDY 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  vi  and  vii. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  ii. 

LABORATORY  EXERCISE  NO.  7 
ILLUSTRATION  OF  STATEMENT  or  PROFIT  AND  Loss 

The  records  of  Howard  Reed,  retail  merchant,  show  that  his  operations 
for  the  year  1918  were  as  follows: 

Merchandise  inventory  January  i       ....  $  9,000.00 

Merchandise  purchases 23,000.00 

Merchandise  sales 30,000.00 

Merchandise  inventory  December  31         ...  12,000.00 

Salaries  of  sales  clerk 2,000.00 

Depreciation  on  furniture  and  fixtures       .       .       .  80.00 


THE  STATEMENT  OF  PROFIT  AND  LOSS  51 

Depreciation  on  delivery  equipment   .       .       .       .       $      7 5.00 

Salary  of  delivery  driver 800.00 

Insurance  on  stock 60.00 

Insurance  on  delivery  equipment        ....  20.00 

Advertising 90.00 

•Salary  of  Howard  Reed 2,000.00 

Traveling  expenses  of  Howard  Reed  on  buying  trips  120.00 

Taxes 70.00 

Postage  and  stationery 30.00 

Wrapping  paper  and  twine 40.00 

Miscellaneous  office  supplies 20.00 

Instructions: 

Prepare  a  statement  of  profit  and  loss  for  the  business  of  Howard  Reed 
for  the  year  1918. 

LABORATORY  EXERCISE  NO.  8 
ILLUSTRATION  OF  THE  STATEMENT  OF  PROFIT  AND  Loss 

The  inventory  of  merchandise  of  the  A.  B.  Company  on  January  i, 
1919,  is  $3,500.00.  During  the  month  of  January  they  purchase  $14,989.00 
of  merchandise  and  sell  $19.500.00.  On  January  31  their  inventory  is 
$3,700.00.  During  the  month  their  expenses  are  as  follows: 

Sales  salaries $500.00 

Advertising 150.00 

Salary  of  delivery  driver   .......  80.00 

Repairs  to  delivery  truck  .......  10.00 

Heat  and  light 100.00 

Telephone  and  telegraph 20.00 

Buying  expenses 75-oo 

Office  salaries ,       .       .       .  200.00 

Office  supplies 80.00 

Insurance  on  building 16.00 

Insurance  on  delivery  truck 2.50 

Insurance  on  stock 8.40 

Depreciation  on  building  .       .       .       .              .       .  14.00 

Depreciation  on  delivery  truck 3.00 

Depreciation  on  furniture  and  fixtures   ....  2.00 

Instructions: 

Prepare  a  statement  of  profit  and  loss  for  the  A.  B.  Company  for  the 
month  of  January. 


$2  PRINCIPLES  OF  ACCOUNTING 

LABORATORY  EXERCISE  NO.  9 
ILLUSTRATION  OF  STATEMENT  OF  PROFIT  AND  Loss 

Lewis  E.  Alward  commences  the  retail  grocery  business  on  June  i, 
investing  the  following  assets: 

Cash $3,000.00^ 

Building 3,000.00 

Lot 1,000.00 

During  the  month  he  purchases  merchandise  on  credit  as  follows: 

On  open  account $4,500.00 

For  notes 1,000.00 

He  sells  merchandise: 

On  account $4,000.00 

For  notes 500.00 

His  cash  receipts  for  the  month  are  as  follows: 

Cash  sales $3,000.00 

Collected  from  customers  on  accounts          .       .       .  2,500.00 

His  cash  disbursements  during  the  month  are  as  follows: 

Cash  purchases  of  merchandise $3,000.00 

Furniture  and  fixtures 200.00 

Clerk  hire  (administrative) 150.00 

Clerk  hire  in  selling  department 300.00 

Heat  and  light 100.00 

Telephone  and  telegraph 8.00 

Advertising 90.00 

Incidentals 40.00 

Stationery 10.00 

Janitor  service .  25.00 

Buying  expenses 80.00 

Paid  trade  creditors  on  account     .....  i  ,400.00 

Paid  on  notes  payable 600.00 

Depreciation  for  month: 

On  building $30.00 

On  furniture  and  fixtures 5.00 

Inventory  of  merchandise  on  hand  June  30,  $3,000.00. 

Instructions: 

Make  a  statement  of  profit  and  loss  showing  Alward's  net  profit  for 
the  month  of  June. 

Make  a  balance  sheet  showing  Alward's  financial  condition  on  June  30. 


CHAPTER  V 

THE  ACCOUNT  AS  A  MEANS  OF  CLASSIFYING 
INFORMATION 

A  means  of  classifying  business  data  needed.  It  should  have 
become  quite  clear  that  the  most  important  function  of  the  accountant 
is  that  of  preparing  such  reports  as  will  be  of  aid  to  the  owner  or 
manager  of  the  business  in  planning  or  conducting  the  operations  of 
the  business.  The  balance  sheet  and  the  statement  of  profit  and  loss 
are  two  reports  which  are  required  in  practically  every  case.  These 
two  reports  may  be  considered  as  typical  of  all  the  accounting  re- 
ports, since  in  these  two  are  reflected  all  the  elements  of  the  business. 
These  reports  are  prepared  at  least  once  a  year  and  hi  many  cases 
much  more  frequently. 

It  is  apparent  from  the  illustrations  of  these  statements  given  in 
the  two  preceding  chapters  that  even  in  a  very  simple  form  of  business 
they  should  contain  a  number  of  items  of  information.  It  should 
also  be  realized  quite  readily  that  during  the  fiscal  period  there  are 
a  great  number  of  transactions  taking  place  which  change  the 
amounts  of  these  items  day  by  day.  It  is  thus  apparent  that 
there  must  be  some  means  employed  for  classifying  the  data  with 
regard  to  all  the  transactions  and  changes  taking  place  in  the  business, 
in  such  a  manner  that  the  information  desired  on  the  reports  may  be 
made  available  at  the  end  of  the  fiscal  period. 

For  instance,  in  order  that  W.  A.  Williams  may  be  able  to  make  a 
balance  sheet  he  must  know  the  amount  of  the  various  items  which 
appear  thereon.  In  the  case  of  some  items,  such  as  cash  and  notes 
receivable,  he  could  obtain  the  amount  by  actual  count.  He  would 
have  no  means  of  knowing,  however,  whether  the  cash  on  hand  was 
actually  correct  unless  he  knew  the  total  cash  received  during  the 
period  and  the  total  cash  paid  out  so  he  could  check  the  amount  of  the 
balance  on  hand  against  the  amount  obtained  by  actual  count.  In 
the  same  way  he  must  know  the  total  amount  of  the  notes  received 
during  the  period  and  the  total  paid  so  he  can  know  the  balance  on 

53 


54  PRINCIPLES  OF  ACCOUNTING 

hand.  In  the  case  of  the  other  items,  such  as  accounts  receivable, 
their  amount  cannot  be  obtained  by  count  because  they  are  not  rep- 
resented by  anything  tangible.  Hence  the  only  possible  means  of 
knowing  the  amount  due  from  customers  is  to  have  a  record  of  the 
amount  of  the  promises  received  from  customers  and  the  promises 
they  have  paid  or  redeemed  so  as  to  obtain  the  difference,  which 
represents  the  accounts  receivable  unpaid.  Again,  it  would  not  be 
possible  to  know  the  amount  of  the  notes  payable  or  accounts  payable 
owed  by  the  business  unless  a  record  is  kept  of  the  written  and  oral 
promises  issued  and  redeemed. 

In  the  case  of  the  statement  of  profit  and  loss,  an  even  more 
apparent  need  of  collecting  such  information  is  seen.  It  is  not  hard 
to  see  that  it  is  entirely  out  of  the  question  for  W.  A.  Williams  to 
know  at  the  end  of  the  period  the  exact  amount  of  the  sales  or  his 
expenses  unless  a  written  record  of  these  classes  of  information  is 
maintained  throughout  the  period.  In  short,  information  sufficiently 
comprehensive  and  exact  for  the  preparation  of  the  balance  sheet  and 
statement  of  profit  and  loss  and  classified  according  to  the  report- 
ing requirements  which  have  been  indicated  can  be  made  available 
only  through  the  use  of  continuous  written  records.  It  is  the  purpose 
of  the  present  chapter  to  explain  the  form  of  record  ordinarily  em- 
ployed by  the  accountant  for  recording  and  classifying  the  information 
necessary  for  the  preparation  of  the  accounting  reports. 

The  account  a  means  of  classification.  Since  it  is  desirable  to 
keep  a  separate  record  of  each  item,  such  as  cash,  accounts  receivable, 
accounts  payable,  sales,  and  selling  expense,  which  is  to  appear  on  the 
balance  sheet  or  statement  of  profit  and  loss,  it  would  seem  the  logical 
thing  to  set  apart  on  the  records  a  space  for  each  such  item  considered 
necessary  for  these  reports  and  to  record  in  that  space  under  a  proper 
heading  all  the  changes  which  take  place  in  connection  with  the  item. 
This  record  would  be  kept  in  such  a  manner  as  to  make  it  possible 
to  reconstruct  the  history  of  that  item  if  so  desired  and  to  secure 
at  any  time  the  information  regarding  it  which  may  be  required  for 
reporting  purposes.  Such  a  record  is  known  in  accounting  as  "the 
account."  In  terms  of  this  discussion  the  account  may  be  defined 
as  a  systematic  record  of  the  changes  taking  place  in  an  item  which 
appears  in  accounting  reports  kept  under  the  title  of  the  item  in 
question.  With  the  aim  of  giving  this  definition 'content,  the  re- 


THE  ACCOUNT  A  MEANS  OF  CLASSIFYING  INFORMATION     55 

mainder  of  this  chapter  will  be  devoted  to  a  discussion  of  the  nature 
of  the  information  which  is  recorded  in  the  account  and  the  form  in 
which  this  information  is  entered.  A  discussion  of  the  character 
and  construction  and  interpretation  of  the  accounts  with  the  indi- 
vidual items  will  be  deferred  to  a  later  chapter. 

As  suggested  in  the  preceding  paragraph,  an  account  is  kept  with 
each  item  of  information  which  is  needed  in  making  an  accounting 
report  such  as  the  balance  sheet  and  statement  of  profit  and  loss. 
Consequently  accounts  are  kept  with  assets  such  as  cash,  notes  receiv- 
able, accounts  receivable,  office  furniture,  and  delivery  equipment; 
with  liabilities  such  as  notes  payable  and  accounts  payable;  with 
expenses  such  as  cost  of  selling  and  administration;  and  with  the 
sources  of  income  such  as  sales.  In  later  chapters  it  will  be  shown 
that  when  more  detailed  information  is  desired  on  the  balance  sheet 
and  the  statement  of  profit  and  loss,  it  is  necessary  to  have  additional 
accounts  so  as  to  obtain  this  information.  For  the  present  it  is  not 
necessary  to  consider  accounts  other  than  those  necessary  to  provide 
the  information  which  appears  on  such  simple  statements  as  the  bal- 
ance sheet  and  the  statement  of  profit  and  loss  of  Williams,  as  given 
in  the  two  preceding  chapters. 

In  some  cases  there  are  special  reports  of  a  statistical  nature 
which  are  prepared  for  some  of  the  subsidiary  managers  and  which 
contain  information  which  is  not  set  forth  in  the  regular  accounts 
but  is  obtained  from  some  form  of  supplementary  records.  The  form 
and  nature  of  such  reports  and  the  method  of  obtaining  the  infor- 
mation which  they  contain  will  be  considered  in  subsequent  chapters. 
For  the  present,  however,  the  discussion  will  be  confined  to  the  means 
of  obtaining  the  information  which  appears  on  the  balance  sheet 
and  the  statement  of  profit  and  loss,  and  this  is  obtained  from  the 
formal  accounting  record  known  as  "the  account." 

As  indicated  by  the  preceding  definition,  the  title  under  which 
the  account  will  be  kept  is  the  name  of  the  item  to  be  shown  in  the 
report.  If  the  reports  are  to  be  of  the  greatest  value  to  the  parties 
to  whom  they  are  submitted,  these  titles  must  be  carefully  chosen. 
The  information  grouped  under  a  single  title  must  so  far  as  possible 
bear  upon  a  single  item  to  be  shown  on  one  of  the  reports  and  the 
title  must  leave  no  doubt  in  the  mind  of  the  reader  with  respect  to 
the  nature  of  that  item.  Thus  in  reporting  the  assets  of  the  firm, 


56  PRINCIPLES  OF  ACCOUNTING 

the  title  "U.S.  Bonds  and  Other  Securities"  is  clearly  one  that  might 
be  misleading  as  to  the  true  condition  of  the  firm.  It  not  only  fails 
to  show  the  amount  of  the  bonds  in  relation  to  the  amount  of  the  other 
securities,  but  gives  the  reader  no  idea  of  the  nature  of  the  others. 
There  is  no  way  to  judge  whether  they  are  conservative  investment 
securities  or  of  the  most  highly  speculative  types.  The  account  title 
of  "Miscellaneous  Expense"  is  one  which  often  results  in  concealing 
useful  information  in  regard  to  the  expenses  of  the  business.  In 
choosing  titles  for  the  accounts  employed,  the  accountant  should  al- 
ways strive  to  make  use  of  titles  which  are  clear,  descriptive,  and 
unambiguous. 

The  form  of  the  account.  In  making  the  accounting  record,  facts 
of  opposite  tendencies  must  often  be  recorded  in  the  same  account. 
For  instance,  in  the  account  with  cash  it  is  necessary  to  record  cash 
received  and  also  cash  paid  out,  so  as  to  be  able  to  offset  the  two  and 
obtain  the  cash  on  hand.  The  same  is  true  with  reference  to  accounts 
receivable  where  it  is  necessary  to  record  both  the  oral  promises 
received  and  the  oral  promises  paid  in  order  to  determine  the  difference 
or  the  accounts  receivable  unpaid.  Since  sooner  or  later  it  may  be 
necessary  to  record  facts  of  opposite  tendencies  in  all  accounts,  it  is 
expedient  to  divide  the  account  into  two  sections  so  as  to  facilitate 
the  recording  of  such  facts.  These  two  sections,  which  for  the  present 
may  be  called  the  right  section  and  the  left  section,  may  be  constructed 
as  shown  in  the  following  illustration: 

CASH 


1919 

1919 

June 

i 

Balance 

— 

2,456 

75 

June 

,so 

Accounts  payable 

— 

i,5°° 

00 

.SO 

Cash  sales 

— 

2,250 

00 

,so 

Notes  payable 

— 

1,500 

oo 

SO 

Accounts  receiv- 

,so 

Salaries  —  sales 

— 

200 

00 

able 

— 

1,400 

00 

.SO 

Office  salaries 

— 

15° 

00 

.30 

Notes  receivable 

— 

800 

00 

.SO 

Delivery  expense 

— 

224 

50 

•SO 

Advertising 

— 

145 

00 

30 

Balance 

— 

3,i87 

25 

6,006 

75 

6,906 

75 

July 

i 

Balance 

3,i87 

25 

It  will  be  seen  from  this  illustration  that  the  columns  employed 
are  the  same  on  each  side  of  the  page.     On  each  of  the  two  sides 


THE  ACCOUNT  A  MEANS  OF  CLASSIFYING  INFORMATION     57 

provision  is  made  for  the  tabulation  of  information  with  regard  to  the 
item  of  cash.  The  facts  which  may  thus  be  recorded  with  reference 
to  each  change  taking  place  in  this  item  are: 

a)  The  date.    Columns  i  and  2  are  used  for  this  purpose,  the 
month  and  the  day  of  the  month,  respectively,  being  entered  in  these 
two  columns.    The  month,  having  once  been  entered,  need  not  be 
entered  again  until  the  month  changes  or  the  account  is  transferred 
to  a  new  page.     It  is  customary  to  indicate  the  year  by  writing  it 
at  the  top  of  column  i  on  each  side  of  a  new  page. 

b)  Any  explanation  of  the  cause  or  nature  of  the  entry   which 
may  seem   desirable  is  entered  in  column  3.     It  will  appear  from 
later  discussion  (see  chaps,  xi  and  xii)  that  it  is  not  often  necessary 
to  enter  any  such  explanation  in  the  account,  and  hi  the  majority  of 
entries  this  space  will  be  left  blank. 

c)  The  business  transaction  or  change  which  affects  the  account 
is  recorded  in  its  entirety  on  another  form  of  record  before  being 
transferred  to  the   accounts  involved.     Column   4,  known  as   the 
folio  column,  is  used  to  show  the  reference  to  the  page  of  the  record 
from  which  the  information  has  been  transferred.    By  referring  to 
this  page,  a  complete  explanation  of  the  transaction  is   available. 
This  is  one  reason  for  the  relatively  infrequent  use  of  the  column  3. 

d)  The  amount  involved  in  each  entry  to  the  account  is  written 
in  column  5,  which  is  divided  hi  to  two  parts,  a  wider  column  for 
the  dollars  and  a  narrow  one  for  the  cents. 

The  balance  of  the  account.  The  object  of  each  account,  as  has 
been  stated,  is  to  give  certain  definite  information  with  regard  to  a  par- 
ticular item,  for  purposes  of  the  accounting  reports.  For  this  purpose 
it  should  be  possible  to  reach  a  conclusion  with  regard  to  the  item 
in  question.  It  is  shown  by  the  foregoing  illustration  how  facts  of 
opposite  tendencies  with  regard  to  an  item  are  recorded  in  the  accounts. 
The  amount  of  cash  on  hand  on  June  i  was  shown  on  the  left-hand  side 
of  the  account,  and  all  additions  to  cash  were  recorded  beneath  it  on 
the  same  side,  while  on  the  right-hand  side  all  subtractions  from  the 
amount  of  cash  were  recorded.  It  is  evident,  then,  that  the  difference 
between  the  total  of  the  right-hand  side  and  that  of  the  left-hand  side 
should  represent  the  amount  of  cash  on  hand  at  the  end  of  the  period. 
The  method  by  which  this  conclusion  is  shown  on  the  account  itself 
is  indicated  in  the  illustration.  The  amount  of  the  difference  between 


58  PRINCIPLES  OF  ACCOUNTING 

the  totals  of  the  two  sides  is  written  on  the  right-hand  side,  and  the 
two  -sides  are  then  totaled,  the  totals  being  entered  opposite  one 
another  on  the  two  sides  of  the  page  and  double  lines  drawn  under 
them  to  indicate  an  equality  to  that  point.  The  amount  of  the 
excess  of  the  left-hand  side  over  the  right  is  then  written  below  the 
double  line  on  the  left-hand  side.  This  figure  represents  the  amount 
of  cash  that  should  be  on  hand  at  that  time,  and  is  known  as  the 
"  balance  "  of  the  account.  If  the  entries  in  a  given  account  are  made 
correctly,  by  writing  all  additions  to  the  item  involved  on  one  side  of 
the  page  and  all  subtractions  on  the  opposite  side,  such  a  balance  may 
always  be  obtained  by  comparing  the  totals  of  the  two  sides,  whether 
the  formal  balancing  of  the  account  is  performed  or  not. 

It  may  happen  that  the  two  sides  of  the  account  are  equal.  In 
this  case  the  account  is  said  to  be  "in  balance,"  and  there  is  no  need 
for  adding  anything  to  either  side  to  bring  about  an  equality,  nor  is 
there  any  balance  to  be  written  below  the  double  lines  on  the  side 
showing  an  excess,  since  no  excess  exists.  Where  this  is  true,  the 
item  involved  will  not  appear  hi  the  reports  for  the  period. 

Interpretation  of  the  account  balance.  The  necessity  of  care  in 
selecting  titles  for  the  individual  accounts  was  probably  sufficiently 
emphasized  in  the  preceding  discussion  of  the  heading  or  title  of  the 
account.  If  proper  care  has  been  exercised  in  this  matter,  there 
should  be  no  difficulty  in  deciding  upon  the  place  of  the  item  in  the 
accounting  reports.  If  the  titles  of  all  the  items  which  appear  hi  the 
reports  are  descriptive  and  unambiguous  so  that  the  student  under- 
stands the  nature  of  each  item  from  the  title,  he  should  have  no 
difficulty  in  the  interpretation  of  the  balance  of  the  accounts  with 
those  items  bearing  the  same  titles.  The  nature  of  the  balance  of 
each  account  is  revealed  by  the  classification  which  is  given  that 
item  on  the  balance  sheet,  statement  of  profit  and  loss,  or  other  formal 
report.  Thus  if  the  item  of  furniture  and  fixtures  is  classified  on  the 
balance  sheet  as  a  fixed  asset,  it  is  clear  that  the  balance  of  the  account 
with  furniture  and  fixtures  represents  the  amount  of  the  fixed  asset. 
When  accounts  receivable  are  shown  as  a  current  asset  on  the  balance 
sheet,  the  meaning  of  the  balance  of  that  account  is  equally  plain. 
The  same  thing  applies  to  the  other  items  on  the  reports,  such  as 
notes  payable  under  current  liabilities,  sales  as  an  item  of  income, 
and  sales  salaries  as  an  item  of  operating  expense. 


THE  ACCOUNT  A  MEANS  OF  CLASSIFYING  INFORMATION     59 

In  the  definition  of  the  account  it  is  stated  that  it  is  a  systematic 
record  of  information.  This  statement  implies  that  a  uniform  pro- 
cedure is  followed  in  the  construction  of  the  account.  The  chief 
factor  in  this  uniform  procedure  is  the  manner  in  which  the  amount 
of  any  change  in  the  item  represented  by  a  particular  account  is 
recorded  in  that  account.  The  illustration  already  given  of  the 
account  with  Cash  indicates  that  additions  to  an  asset  are  recorded 
on  the  left-hand  side  of  the  asset  account  affected,  and  that  sub- 
tractions are  entered  on  the  opposite,  or  right-hand^  side  of  the 
account.  Accounts  with  kinds  of  expenses  resemble  asset  accounts 
in  the"  fact  that  they  represent  values  received  by  the  business, 
though  the  values  entered  as  expense  are  those  which  have  been  used 
up  in  securing  income.  Like  additions  to  assets,  additions  to  ex- 
pense are  recorded  on  the  left-hand  side  of  the  appropriate  expense 
accounts.  Any  deduction  from  an  expense  is  recorded  on  the  right- 
hand  side  of  the  expense  account. 

In  the  case  of  liability  accounts,  which  are  opposite  in  their 
nature  to  asset  accounts,  the  additions  to  the  liability  in  question  are 
shown  on  the  right-hand  side,  and  the  subtractions  on  the  left-hand 
side.  Income  accounts  represent  items  of  a  nature  opposite  to  that 
of  expense.  Additions  to  income  are  therefore  entered  on  the  right- 
hand  side  of  the  income  accounts  involved,  and  subtractions  from  such 
income  are  entered  on  the  left-hand  side  of  the  income  account. 

It  has  been  explained  that  proprietorship  is  the  excess  of  the  total 
assets  of  the  business  over  its  total  liabilities.  Since  the  total  of  the 
assets  is  equal  to  the  sum  of  all  the  liabilities  and  the  proprietorship, 
it  is  a  part  of  the  uniform  procedure  to  enter  additions  to  proprietor- 
ship on  the  right-hand  side  of  the  proprietorship  account  affected 
and  deductions  on  the  left-hand  side.  Thus  the  credit  balances  of  the 
liability  and  proprietorship  accounts  are  set  over  against  the  debit 
balances  of  the  asset  accounts,  while  the  credit  balances  of  the  income 
accounts  are  set  over  against  the  debit  balances  in  the  accounts 
which  show  the  expenses  incurred  in  securing  that  income. 

Consequently  the  balance  of  an  account  which  is  larger  on  the 
left  side  represents  either  an  asset  or  an  expense,  while  the  balance 
of  the  account  which  is  larger  on  the  right  side  represents  either  a 
liability,  a  source  of  income,  or  proprietorship.  As  previously  stated,  if 
the  student  is  familiar  with  the  items  which  appear  on  the  accounting 


60  PRINCIPLES  OF  ACCOUNTING 

reports  he  will  have  no  difficulty  in  interpreting  the  balance  of  the 
accounts  kept  with  these  items. 

•The  ledger  and  Us  contents.  The  accounts  of  the  business  are 
arranged  in  systematic  order  in  a  book  called  the  ledger.  The  ledger 
is  usually  a  bound  book,  the  pages  of  which  are  ruled  as  shown  on 
page  62.  It  is  some  tunes  denned  as  the  book  of  accounts.  In  it  is 
collected  hi  summarized  form,  under  proper  account  titles,  the  infor- 
mation necessary  to  make  the  accounting  reports.  There  should  be 
an  account  kept  with  each  item  of  information  which  the  owners 
desire  to  appear  on  the  reports. 

The  number  of  accounts  kept  will  vary  with  the  size  of  the  busi- 
ness, the  number  and  types  of  assets  and  liabilities  involved,  the 
complexity  of  its  operations,  and  more  especially  with  the  manner 
hi  which  the  business  is  organized,  since  the  number  and  complexity  of 
the  reports  needed  to  exercise  control  in  the  business  vary  with  all  of 
these  factors.  It  is  true  that  it  is  a  waste  of  energy  to  maintain 
accounts  which  are  not  used  in  preparing  the  reports.  It  is  equally 
true  that  care  must  be  exercised  that  an  analysis  of  the  facts  regarding 
the  business  and  its  operations  is  kept  in  sufficient  detail  to  make 
available  all  information  needed  for  the  reports.  It  is  easier  to  com- 
bine information  where  too  many  accounts  have  been  maintained 
than  to  reconstruct  an  analysis  where  several  items  which  should 
have  been  kept  separate  have  been  included  under  one  account. 
The  principles  governing  the  arrangement  and  use  of  the  ledger  will 
be  developed  in  the  next  few  chapters  through  discussion  and  illus- 
trative exercises  involving  comparatively  simple  accounts,  and  these 
principles  will  be  applied  later  to  business  problems  of  greater 
complexity. 

The  use  of  the  terms  debit  and  credit  in  relation  to  the  account.  It 
has  been  explained  in  the  preceding  paragraphs  that  the  account  is 
divided  into  two  sides  and  that  additions  to  the  item  with  which  the 
account  is  kept  are  shown  on  one  side  and  subtractions  on  the  other 
side".  It  has  also  been  stated  that  it  is  the  practice  of  accountants 
to  use  the  left-hand  side  for  recording  additions  to  assets  and  expenses 
and  the  right-hand  side  for  recording  additions  to  liabilities,  income, 
and  proprietorship.  Among  accountants  and  others  familiar  with 
accounting,  the  terms  "left-hand"  and  "right-hand"  are  not  em- 
ployed, but  the  two  sides  of  the  account  are  known  respectively  as  the 
"debit "and  "credit "sides. 


THE  ACCOUNT  A  MEANS  OF  CLASSIFYING  INFORMATION     61 

Following  out  this  terminology,  the  entering  of  any  item  of  infor- 
mation on  the  left-hand  side  of  the  account  is  referred  to  as  "debiting" 
the  account,  and  entering  such  an  item  on  the  right-hand  side  as 
"crediting"  the  account.  When  an  item  is  entered  on  the  left-hand 
side  of  the  account  it  is  called  a  "debit"  to  that  account,  and  when 
on  the  right-hand  side,  a  "credit."  Similarly  an  account  in  which 
the  total  of  the  left  side  exceeds  the  total  of  the  right  is  said  to  have  a 
"debit  balance,"  while  one  in  which  an  excess  occurs  on  the  right  side 
of  the  account  is  said  to  have  a  "credit  balance."  If  the  student  will 
familiarize  himself  with  the  use  of  these  terms  as  used  in  relation  to 
the  account,  he  should  not  experience  any  difficulty  either  in  applying 
them  or  in  understanding  them  as  employed  in  the  literature  of 
accounting. 

Considerable  space  is  devoted  by  some  writers  to  the  discussion 
of  the  original  significance  of  the  terms  debit  and  credit  and  to  the 
historical  development  of  their  use.  A  comparison  of  the  various 
methods  of  approach  that  have  been  employed  in  attempting  to 
introduce  the  student  to  their  use  would  afford  an  interesting  study, 
if  not  a  particularly  useful  one.  Such  discussion,  however,  has  little 
bearing  on  the  functions  of  accounting  and  will  not  be  introduced 
here,  lest  it  confuse  the  student.  For  the  purposes  of  this  text,  if  the 
student  understands  the  way  in  which  the  terms  are  employed  as 
outlined  above,  he  has  all  the  information  concerning  them  which  will 
prove  of  any  marked  value  to  him. 

Accounts  affected  by  business  transactions.  In  order  to  maintain 
or  increase  the  amount  of  the  net  investment  of  the  business,  the 
operations  for  which  the  business  is  organized  must  be  carried  on  more 
or  less  continuously.  This  means  that  the  various  items  with  which 
accounts  are  kept,  the  assets,  liabilities,  sources  of  income,  and  kinds 
of  expense  will  be  continually  changing  hi  their  amounts.  Such 
changes  are  the  result  of  business  transactions.  Since  it  is  the  func- 
tion of  the  accountant  to  report  the  results  of  the  business  operations, 
it  is  desirable  that  the  relation  of  the  business  transactions  to  the 
accounts  be  considered. 

A  business  transaction  may  be  defined  as  an  exchange  of  values. 
As  a  result  of  such  exchanges  certain  values  are  received  by  the  busi- 
ness and  certain  values  are  surrendered  by  the  business.  If  Williams 
sells  groceries  to  a  customer  for  cash,  a  value  hi  the  form  of  cash  is 
received  and  a  value  in  the  form  of  merchandise  is  surrendered. 


62 


PRINCIPLES  OF  ACCOUNTING 


When  he  purchases  merchandise  on  account,  giving  his  oral  promise 
to  pay,  a  value  is  received  in  the  form  of  merchandise,  while  an  equal 
amount  of  value  is  surrendered  through  the  assumption  of  an  addi- 
tional liability  by  the  business.  If  Williams  pays  a  certain  amount 
for  clerk  hire,  the  value  he  receives  is  the  services  rendered  by  the 
clerk,  while  the  value  parted  with  is  the  amount  paid  to  the  clerk. 
So  in  the  case  of  every  transaction  there  is  an  exchange  of  values  and 
it  is  the  function  of  accounting  to  record  these  values,  both  those 
received  and  those  parted  with. 

In  accounting,  the  values  received  are  called  "debits1"  and  re- 
corded on  the  debit  side  of  the  account  to  which  they  pertain,  and  the 
values  given  up  are  called  "credits"  and  recorded  on  the  credit  side 
of  the  account  to  which  they  pertain.  It  can  be  seen,  therefore,  that 
every  transaction  affects  at  least  two  accounts,  involving  a  debit  to 
one  and  a  credit  to  the  other.  An  illustration  of  the  two  will  make 
this  more  apparent.  If  $800  of  merchandise  is  sold  for  cash  during  the 
month  of  January,  the  value  received  is  $800  of  cash.  Therefore  the 
cash  account  will  be  debited  as  follows: 

CASH 


1919 

January 

Merchandise 

800 

oo 

1919 

The  value  parted  with  is  the  merchandise.  When  merchandise 
is  sold  it  is  termed  a  sale,  so  the  sales  account  will  be  credited  as 
follows: 

SALES 


1919 

1919 

January 

Cash 

800 

oo 

If  during  the  same  month  $400  of  merchandise  is  purchased  for 
cash,  the  effect  on  the  business  is  just  the  reverse.  The  value  received 
is  the  merchandise.  When  merchandise  is  purchased  it  is  termed 
"purchases";  so  the  purchases  account  will  be  debited  as  follows: 


PURCHASES 


1919 

January 

Cash 

400 

oo 

THE  ACCOUNT  A  MEANS  OF  CLASSIFYING  INFORMATION     63 

The  value  parted  with  is  the  cash,  which  will  be  credited  to  the 
cash  account.    This  account  will  then  appear  as  follows: 


CASH 


1919 

January 

Merchandise 

800 

00 

1919 
January 

Purchases 

400 

oo 

If  Williams  pays  $100  for  a  sales  clerk  during  the  month,  the  value 
received  is  the  services  of  the  clerk,  which  will  be  recorded  as  a  selling 
expense.  The  selling  expense  account  will  therefore  appear  as  follows: 

SELLING  EXPENSE 


1919 

January 

Cash 

100 

oo 

The  value  parted  with  is  the  cash  which  will  be  credited  to  the 
cash  account  and  this  account  will  then  appear  as  follows: 


CASH 


1919 

1919 

January 

Merchandise 

800 

oo 

January 

Purchases 

400 

oo 

Selling  expense 

100 

00 

Determination  of  debits  and  credits  to  accounts.  Many  attempts 
have  been  made  to  give  fixed  rules  for  the  debiting  and  crediting  of 
accounts.  As  suggested  previously,  the  determination  of  the  debits 
and  credits  resulting  from  a  transaction  necessitates  that  the  trans- 
action be  analyzed  and  the  value  or  values  received  by  the  business 
and  the  value  or  values  parted  with  by  the  business  be  ascertained, 
after  which  the  former  are  debited  to  the  account  to  which  they 
pertain  and  the  latter  credited  in  the  same  manner.  If  it  is  desired 
to  express  this  as  a  formula,  it  might  be  stated  as  follows:  Debit  the 
appropriate  account  for  all  values  received  and  credit  the  appropriate 
account  for  all  values  parted  with.  The  application  and  illustration 
of  this  statement  with  reference  to  particular  accounts  will  be  given 
in  the  chapters  immediately  following. 

Equality  of  debits  and  credits  to  the  accounts.  The  business  trans- 
action has  been  denned  as  an  exchange  of  values,  and  it  has  been 
shown  that  in  recording  such  an  exchange  there  will  necessarily  be  an 


64  PRINCIPLES  OF  ACCOUNTING 

equality  between  the  debits  and  the  credits  recorded.  Thus  all 
debits  to  accounts  showing  receipts  of  value  will  be  accompanied  by 
equal  credits  to  accounts  showing  surrender  of  value.  And  all  credits 
to  accounts  showing  surrenders  of  value  will  be  accompanied  by 
equal  debits  to  accounts  showing  the  receipts  of  value.  It  follows 
from  this  that  there  must  be  at  all  tunes  an  equality  between  the 
total  debits  made  to  the  accounts  and  the  total  credits.  One  manner 
jn  which  the  student  should  test  the  correctness  of  his  analysis  of  any 
transaction  or  other  change  to  be  recorded  is  to  make  sure  that  the 
total  of  the  debits  to  be  recorded,  according  to  his  analysis,  is  equal 
to  the  total  credits  to  be  recorded.  Some  of  the  uses  that  are  made  of 
the  existence  of  this  equality  between  debits  and  credits,  and  some 
of  the  means  of  testing  it,  will  be  discussed  later  in  this  course. 

QUESTIONS  FOR  CLASS  DISCUSSION 

i.  You  have  purchased  the  business  of  H.  M.  James,  retail  merchant, 
with  the  agreement  that  you  are  to  acquire  his  assets,  assume  his 
liabilities,  and  pay  him  the  amount  of  his  net  worth  as  shown  by  his 
balance  sheet.  He  presents  a  balance  sheet  which  shows  accounts 
receivable  to  the  amount  of  $12,000.00.  What  additional  information 
would  you  request  with  reference  to  this  item  ?  How  would  you  verify 
the  information  which  he  provides  ? 

a.  You  are  requested  to  instal  an  accounting  system  for  Brown  &  King, 
wholesale  merchants.  What  information  would  you  desire  before 
deciding  upon  the  accounts  which  should  be  maintained  on  their  ledger  ? 

3.  Explain  the  construction  of  an  account. 

4.  The  cash  on  hand  on  January  i  is  $1,400.00.    How  would  this  be 
shown  in  the  cash  account  ? 

5.  During  the  month  $4,000.00  of  cash  is  received  and  $4,200.00  of  cash 
is  paid  out.    How  would  this  be  shown  in  the  cash  account  ? 

6.  How  would  the  cash  on  hand  on  February  i  be  determined  ? 

7.  How  are  addition  and  subtraction  indicated  in  the  account  ? 

8.  Explain  and  illustrate  the  meaning  of  the  terms  "debit"  and  "credit." 

9.  Explain  and  illustrate  how  transactions  are  recorded  in  accounts. 

10.  The  following  list  of  account  balances  is  taken  from  the  ledger  of 
A.  B.  Johnson: 
Selling  Expenses       .       .       .       ...       .       .      $   400.00 

Delivery  Equipment 600.00 

Land .        2,000.00 

Buying  Expenses 100.00 


THE  ACCOUNT  A  MEANS  OF  CLASSIFYING  INFORMATION     65 

Sales $12,000.00 

Merchandise  Inventory 3,000.00 

Purchases 10,000.00 

Accounts  Payable 4,000.00 

Notes  Receivable 200.00 

Notes  Payable 1,200.00 

Cash 800.00 

Delivery  Expenses 340.00 

Administrative  Expenses 1,420.00 

Building 2,000.00 

Accounts  Receivable 3,800.00 

A.  B.  Johnson,  Proprietor 2,600.00 

State  which  of  these  represent  debit  and  which  credit  balances. 

11.  If  transactions  are  recorded  properly  in  the  accounts,  what  relation 
exists  between  the  debits  and  credits  shown  by  the  accounts  ? 

12.  Name  the  debits  and  credits  resulting  from  the  following  transactions: 

a)  Purchase  merchandise  for  cash,  $200.00. 

b)  Purchase  merchandise  from  R.  L.  James  on  account,  $300.00. 

c)  Sell  merchandise  to  C.  R.  Laws  on  account,  $18.00. 

d)  Pay  $40.00  for  services  of  stenographer. 

e)  Pay  A.  B.  Hill  $20.00  to  apply  on  account. 

/)  Receive  $40.00  from  J.  T.  Hensley  to  apply  on  account. 

g)  Pay  $80.00  for  rent  of  store. 

K)  Sell  for  cash  merchandise,  $75.00. 

t)  Pay  for  services  of  sale  clerk,  $50.00. 

i)  Receive  from  A.  P.  James  $40.00  to  apply  on  account. 

REFERENCES  FOR  FURTHER  STUDY 
SPRAGUE,  CHAS.  E.,  The  Philosophy  of  Accounts,  chaps,  i-iv.  f 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  x  and  xi. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  chaps,  ii 

and  iii. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  iv. 

LABORATORY  EXERCISE  NO.  10 

ILLUSTRATION  OF  THE  ACCOUNT 

The  following  transactions  were  performed  by  J.  B.  Adams,  retail 
merchant,  during  the  month  of  June: 

1.  Purchased  of  J.  H.  Bishop  &  Co.  on  account,  merchandise,  $246.00. 

2.  Paid  rent  for  the  month,  $60.00. 

3.  Purchased  of  L.  S.  Lyon  &  Co.  on  account,  merchandise,  $340.00. 


66  PRINCIPLES  OF  ACCOUNTING 

4.  Sold  to  A.  B.  Hill  for  cash,  merchandise,  $46.0x3. 

5.  Sold  to  H.  M.  Peabody  on  account,  merchandise,  $27.00. 

7.  Paid  stenographer  one  week's  salary,  $25.00. 

8.  Purchased  of  Marshall  Field   &  Co.   on  account,  merchandise, 
$250.00. 

9.  Purchased  of  the  Acme  Furniture  Co.  for  cash,  desk  and  chair  for 
office  use,  $100.00. 

10.  Received  from  A.  K.  Long  to  apply  on  account,  $23.00. 

11.  Paid  James  Langley  &  Co.  on  account,  $82.00. 

12.  Received  a  thirty-day  note  for  $27.00  from  A.  B.  James  to  apply 
on  account. 

14.  Paid  sales  clerk  for  two  weeks'  services,  $40.00. 

14.  Paid  $10.00  for  repairs  on  delivery  equipment. 

15.  Paid  $12.00  for  repairs  on  building. 

17.  Received  $20.00  from  Alfred  Long  to  apply  on  account. 

19.  Sold  M.  M.  McGee  on  account,  merchandise,  $16.80. 

20.  Paid  for  services  of  delivery  driver,  $60.00. 

21.  Paid  for  expenses  of  buying  trip  of  Mr'.  Adams,  $39.40. 

23.  Paid  the  King  Coal  Co.  $30.00  for  coal  to  be  used  in  heating  store 
building. 

24.  Paid  local  newspaper  $32.00  for  advertising. 

26.  Paid  J.  H.  Bishop  &  Co.  $246.00  in  full  of  account. 

27.  Purchased  on  account  from  Chicago  Wholesale  Co.,  merchandise, 
$450.00. 

30.  Paid  the  following  expenses  for  the  month: 

Light $    4.00 

Telephone 5.00 

Telegraph 3.00 

Sales  salaries 120.00 

Stenographer  and  bookkeeper 100.00 

Instructions: 

Draw  a  line  lengthwise  through  the  center  of  a  sheet  of  note  paper. 
On  the  left  of  the  line  write  the  debit  items  and  on  the  right  of  the  line  the 
credit  items  resulting  from  the  foregoing  transactions.  Merchandise  pur- 
chased will  be  recorded  as  "purchases,"  and  merchandise  sold  as  "sales." 
The  first  two  transactions  when  recorded  will  appear  as  follows: 
Purchases  .  .  .  $246.00  J.  H.  Bishop  &  Co.  .  $246.00 
Administrative  Expense  60.00  Cash 60.00 


CHAPTER  VI 

THE  CONSTRUCTION  AND  INTERPRETATION  OF 
PARTICULAR  ACCOUNTS 

Certain  facts  to  be  considered  in  interpreting  accounts.  In  the 
preceding  chapter  the  use  of  accounts  as  a  means  of  obtaining  the 
information  necessary  to  make  the  accounting  reports  which  are 
needed  in  the  business  and  the  general  principles  regarding  the  con- 
struction of  accounts  have  been  discussed.  The  analysis  of  business 
transactions  according  to  their  effect  on  the  various  accounts  has  also 
been  considered.  The  next  step  is  to  explain  the  application  of  these 
principles  in  the  construction  and  interpretation  of  particular  accounts. 

In  order  to  understand  the  construction  and  interpretation  of  an 
account,  three  things  must  be  considered:  (i)  The  object  or  purpose 
of  the  account,  i.e.,  the  information  which  it  is  desired  to  obtain 
from  the  account.  (2)  The  transactions  which  are  to  be  recorded  in 
it  or  the  debits  and  credits  which  are  made  to  it.  (3)  What  the 
balance  of  the  account  represents  and  what  disposition  is  made  of  this 
balance  on  the  accounting  reports. 

The  following  discussion  considers  certain  typical  accounts,  the 
ones  selected  being  such  as  would  ordinarily  be  required  in  a  small 
retail  business  like  that  of  Mr.  Williams.  The  ami  of  the  discussion 
is  to  apply  each  of  the  three  tests  stated  above  to  the  interpretation 
of  each  of  the  accounts  considered.  Later,  still  other  accounts  will  be 
considered  in  the  same  manner. 

Cash  account.  The  term  cash,  as  used  in  accounting,  refers  to 
money  of  all  kinds  and  to  commercial  paper  such  as  will  pass  readily 
as  a  medium  of  exchange.  Such  paper  includes  personal  checks, 
cashiers'  checks,  bank  drafts,  so-called  travelers'  checks,  and  postal  and 
express  money  orders.  It  also  includes  funds  on  deposit  with  the  bank. 

The  purpose  of  the  cash  account  is  to  show  the  cash  received, 
cash  paid  out,  and  the  difference,  or  the  cash  on  hand.  This  account, 
therefore,  is  affected  by  every  transaction  which  involves  either  the 
receipt  or  payment  of  cash. 

67 


68 


PRINCIPLES  OF  ACCOUNTING 


The  debits  and  credits  to  the  cash  account  are  as  follows: 

CASH 


Debit: 

With  cash  received. 
Usually  this  account  is  not  debited  with 

individual  cash  items,  but  for  daily, 

weekly,  or  monthly  totals. 


Credit: 

With  cash  paid. 

Usually  this  account  is  not  credited 
with  individual  cash  items,  but  for 
daily,  weekly,  or  monthly  totals. 


The  balance  of  the  cash  account  must  always  be  on  the  debit 
side,  since  cash  is  an  asset  and  it  is  impossible  to  disburse  more  cash 
than  is  on  hand.  The  balance  represents  the  amount  of  cash  actually 
on  hand  and  available  for  use  in  the  business.  It  may  be  that  through 
some  error  the  amount  which  is  shown  as  that  which  should  be  on 
hand  does  not  agree  with  that  which  is  actually  on  hand.  If  so,  it  is 
very  important  that  this  should  be  learned,  the  reason  accounted  for, 
and  the  error  corrected.  For  this  reason  it  is  desirable  that  a  proof  of 
cash  should  be  made  from  tune  to  time  to  check  the  accuracy  of  the 
cash  balance.  This  involves  the  ascertainment  of  the  total  cash  on 
hand  by  adding  the  amount  of  cash  credited  at  the  bank  to  the  cash 
held  by  the  business  in  any  form  outside  of  the  bank  and  comparing 
this  with  the  total  shown  by  the  cash  account.  In  many  businesses 
such  a  proof  is  made  daily.  It  certainly  should  be  made  at  frequent 
intervals. 

Accounts  with  debtors.  In  most  businesses  merchandise  is  sold 
on  credit.  In  a  retail  business  goods  are  usually  sold  on  open  account, 
i.e.,  oral  promises  are  received  in  payment  for  them.  In  some  cases, 
however,  written  promises  or  notes  are  received  in  payment  of  the 
merchandise  or  hi  payment  of  the  oral  promises  originally  received 
in  payment  for  merchandise.  On  the  balance  sheet  the  written 
payments  of  customers  are  shown  as  notes  receivable  and  the  oral 
promises  are  shown  as  accounts  receivable.  It  is  desirable,  therefore, 
to  have  accounts  from  which  the  amount  of  each  of  these  items  can  be 
obtained. 

X 

Notes  receivable.  Since  written  promises  received  from  customers 
are  not  usually  numerous,  it  is  customary  to  record  all  notes  receivable 
in  one  account.  The  amount  due  from  each  customer  on  notes  can 
be  determined  at  any  time  by  examining  the  amount  of  the  notes  on 
hand.  The  date  of  payment  or  other  information  desired  about  the 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS        69 


note  can  be  determined  in  the  same  manner.  It  is  not  necessary, 
therefore,  to  have  a  separate  account  with  the  notes  due  from  each 
customer. 

The  purpose  of  the  "Notes  Receivable"  account  is  to  show  the 
notes  received  from  others,  the  amount  received  from  them  in  pay- 
ment of  these  notes,  and  the  balance,  which  is  the  amount  of  notes 
receivable  now  held  by  the  business.  The  correctness  of  this  amount 
can  be  ascertained  by  comparing  it  with  the  amount  of  notes  on  hand. 

The  debits  and  credits  to  the  "Notes  Receivable"  account  are  as 
follows: 

NOTES  RECEIVABLE 


Debit: 

With  the  face  value  of  all  notes  received 
in  favor  of  the  business. 


Credit: 
With  the  amount  of  cash  or  other 

property  received  in  payment  of 

notes. 
With  the  face  value  of  any  notes 

transferred  or  disposed  of. 


Since  the  "Notes  Receivable"  account  is  always  debited  for  the 
face  value  of  the  notes  received  and  credited  with  the  face  value  of 
notes  paid,  canceled,  or  surrendered,  it  is  quite  clear  that  the  balance 
of  this  account  must  always  be  on  the  debit  side,  since  the  business 
will  not  receive  more  in  payment  of  notes  than  there  is  due.  The 
balance  is  shown  on  the  balance  sheet  as  a  current  asset. 

Accounts  receivable.  In  a  retail  business  the  oral  promises  re- 
ceived from  customers  are  usually  quite  numerous;  consequently, 
unlike  notes  receivable,  it  is  necessary  to  have  a  separate  account  or 
record  with  each  customer.  There  are  many  different  methods 
employed  in  keeping  a  record  of  the  amount  due  from  customers. 
The  purpose  of  the  present  discussion,  however,  is  to  explain  to  the 
student  the  principles  involved  in  the  construction  of  accounts  rather 
than  the  practices  of  any  particular  business.  Consequently,  a 
consideration  of  special  methods  of  recording  accounts  receivable 
will  be  postponed  for  the  present. 

The  purpose  of  the  accounts  receivable,  or  "customer's"  account, 
is  to  show  the  oral  promises  received  from  a  customer  to  whom  mer- 
chandise has  been  sold  on  account,  the  amount  paid  by  the  customer 
in  settlement  of  the  amount  due,  and  the  balance,  which  represents 
the  amount  remaining  unpaid. 


70  PRINCIPLES  OF  ACCOUNTING 

The  debits  and  credits  to  a  customer's  account  are  as  follows: 

ACCOUNTS  RECEIVABLE 
(Separate  Accounts  with  Each  Customer) 


Debit: 

With  the  amount  of  the  account  sales  of 
merchandise  to  a  customer. 


Credit: 

With  cash  received  from  a  customer 
to  apply  on  account. 

With  a  note  or  other  property  re- 
ceived to  apply  on  account. 

With  any  allowance  or  deduction 
made  to  a  customer. 


Since  customers  will  not  pay  more  than  they  owe  and  the  debit 
side  shows  the  amount  due  and  the  credit  side  the  amount  paid, 
it  follows  that  the  debit  side  will  always  be  the  larger.  The  sum 
of  the  balances  of  all  the  customers'  accounts  is  shown  on  the 
balance  sheet  as  a  current  asset  under  the  heading  of  "Accounts 
Receivable." 

Accounts  -with  creditors.  When  a  business  sells  merchandise  on 
credit  it  usually  finds  it  necessary  to  purchase  on  credit,  in  which  case 
it  may  give  either  its  written  or  its  oral  promises  in  payment  of  the 
merchandise  purchased.  The  written  promises  are  shown  on  the  bal- 
ance sheet  as  "  Notes  Payable "  and  the  oral  promises  as  "  Accounts 
Payable."  Since  these  items  are  shown  separately  on  the  balance 
sheet,  separate  accounts  must  be  carried  with  them.  Separate 
records  also  facilitate  the  prompt  payment  of  debts  due  to  creditors. 

Notes  payable.  The  notes  issued  by  the  business  in  favor  of 
others  are  usually  not  numerous,  so  notes  payable,  like  notes  receiv- 
able, are  recorded  in  one  account.  As  will  be  explained  later,  there 
is  sometimes  another  record  besides  the  ledger  account  kept  with 
both  notes  receivable  and  notes  payable,  but  in  any  case  only  one 
ledger  account  is  kept  with  each. 

The  purpose  of  the  notes  payable  account  is  to  show  the  notes 
issued  in  favor  of  others  by  the  business,  the  amount  paid  in  liqui- 
dation of  these  notes,  and  the  balance,  or  the  notes  still  owed.  This 
account  is  affected  by  all  transactions  which  increase  or  decrease  the 
amount  of  the  notes  of  the  business  outstanding. 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS   71 

The  debits  and  credits  to  the  Notes  Payable  account  are  as  follows: 
NOTES  PAYABLE 


Debit: 

With  the  amount  paid  in  settlement  of 
notes  owed. 


Credit: 

With  the  face  value  of  notes  issued 
by  the  business. 


The  credit  side  of  the  Notes  Payable  account  is  always  the  larger 
and  the  balance  is  shown  on  the  balance  sheet  as  a  current  liability. 

Accounts  payable.  The  accounts  payable  of  the  ordinary  whole- 
sale or  retail  mercantile  business  are  usually  not  so  numerous  as  its 
accounts  receivable.  To  make  a  record  of  them,  therefore,  is  not  so 
burdensome  a  task.  Although  in  some  businesses  a  separate  ledger 
account  is  not  kept  with  each  creditor,  for  the  purpose  of  the  present 
discussion  and  illustrations  such  a  practice  may  be  assumed. 

The  purpose  of  an  accounts  payable  or  "creditor's"  account  is  to 
show  the  oral  promises  issued  by  the  business  to  a  creditor  from  whom 
merchandise  has  been  purchased  on  account,  the  amount  paid  in 
settlement  thereof,  and  the  balance  or  the  amount  still  owed  to  the 
creditor.  A  creditor's  account  is  affected  by  all  transactions  which 
cause  an  increase  or  decrease  in  the  amount  due  him. 

The  debits  and  credits  to  a  creditor's  account  are  as  follows: 

ACCOUNTS  PAYABLE 
(Separate  Accounts  with  Each  Creditor) 


Debit: 
With  cash  paid  or  notes  issued  to  a 

creditor  to  apply  on  account. 
With  allowances  or  deductions  granted 

by  a  creditor  which    decrease    the 

amount  owed. 


Credit: 

With  purchases  of  merchandise  on 
account  from  a  creditor. 


Since  more  will  not  be  paid  to  a  creditor  than  is  owed  to  him,  except 
by  mistake,  the  credit  side  of  this  account  should  always  be  the  larger. 
The  balance  of  the  account  is  a  current  liability  and  is  so  shown  on  the 
balance  sheet. 

Accounts  with  fixed  assets.  In  a  previous  chapter  it  is  stated  that 
the  assets  of  a  business  may  be  divided  into  two  classes:  those  which 
are  in  the  form  of  cash  or  which  will  be  liquidated  in  cash  within  a 


72  PRINCIPLES  OF  ACCOUNTING 

relatively  short  time  in  the  regular  operations  of  the  business,  and 
those  which  the  owner  plans  to  retain  in  the  business.  As  previously 
explained,  the  former  are  known  as  current  assets  and  the  latter 
as  fixed  assets.  The  construction  and  interpretation  of  the  accounts 
with  some  of  the  principal  current  assets,  such  as  cash,  accounts 
receivable,  and  notes  receivable,  has  been  discussed.  The  construc- 
tion of  accounts  with  such  fixed  assets  as  office  furniture  and  delivery 
equipment  may  now  be  examined. 

In  every  business  certain  equipment,  such  as  desks,  chairs, 
tables,  counters,  typewriters,  adding  machines,  etc.,  is  employed. 
This  equipment  is  known  by  various  terms,  but  may  appropriately  be 
called  "office  equipment."  The  business,  of  course,  does  not  pur- 
chase this  equipment  for  purposes  of  resale,  although,  of  course,  it 
may  be  sold  as  scrap  when  the  asset  can  no  longer  be  used  in  the 
business.  The  manager  intends  to  retain  it  for  use  hi  the  business, 
and  such  use,  of  course,  will  cause  it  to  decrease  steadily  in  value. 
This  decrease  in  value  takes  place  during  the  entire  life  of  the  asset, 
and  its  amount  should  be  distributed  over  the  period  of  its  life. 

For  instance,  if  the  proprietor  purchases  for  $100  a  typewriter 
which  will  give  satisfactory  service  for  ten  years,  and  has  a  scrap 
value  of  $20  at  the  end  of  that  tune,  his  investment  hi  the  typewriter 
has  evidently  declined  hi  value  during  that  period  by  the  amount  of 
$80.  This  yearly  decrease  hi  value  of  the  typewriter,  due  to  its  use 
in  the  business,  which  is  known  in  accounting  as  "depreciation," 
must  be  shown  in  the  accounting  records  in  two  ways.  It  must  be 
shown  as  a  deduction  from  the  asset  value  of  the  typewriter  and  it 
must  also  be  shown  as  an  expense  of  the  business.  The  student 
should  readily  realize  that  if  the  typewriter  will  be  decreased  in  value 
$80  in  ten  years,  it  would  be  unwise  to  wait  until  the  end  of  ten  years 
and  then  show  the  entire  decrease.  The  balance  sheets  made  up  in 
the  meantime  would  show  the  typewriter  at  its  original  value  of  $100, 
which  would  be  clearly  erroneous.  This  yearly  decrease  in  value 
should  also  be  treated  as  an  expense  of  conducting  the  business,  just 
as  a  yearly  rental  of  $8  would  be  treated. 

The  proper  recording  of  the  depreciation  which  arises  from  their 
use  in  the  business  is  the  chief  accounting  problem  in  connection  with 
the  accounting  for  fixed  assets.  With  a  very  few  exceptions,  such  as 
certain  kinds  of  land,  or  the  roadbed  of  a  railroad,  this  depreciation 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS        73 

is  continually  going  on  in  connection  with  fixed  assets,  and  it  is 
emphasized  at  this  point  so  that  the  student  will  see  from  the  very 
beginning  of  his  study  of  accounting  that  no  accurate  or  trustworthy 
reports  can  be  made  concerning  the  financial  condition  of  a  business 
unless  the  depreciation  of  its  fixed  assets  is  taken  into  consideration. 
As  stated  in  chapter  iii,  it  is  customary  for  the  owner  to  retain  or 
reserve  in  the  business  sufficient  of  his  profits  to  cover  the  amount  of 
the  estimated  depreciation  of  his  fixed  assets.  This  estimated 
decrease,  which  is  called  a  "reserve  for  depreciation,"  is,  as  illustrated 
in  the  preceding  chapter,  shown  on  the  balance  sheet  as  a  deduction 
from  the  original  cost  of  the  asset.  For  instance,  in  the  balance 
sheet  of  W,  A.  Williams  his  furniture  and  fixtures  are  shown  as 
follows : 

Furniture  and  fixtures       ..... 
Less  reserve  for  depreciation    .... 

$450.00 

If  the  original  cost  of  the  fixed  asset  and  the  amount  by  which  it 
has  depreciated  are  to  be  shown  as  separate  items  on  the  balance 
sheet,  it  will  be  realized,  since  this  information  is  obtained  from  the 
accounts,  that  two  accounts  must  be  kept  with  each  fixed  asset  sub- 
ject to  depreciation.  The  construction  and  interpretation  of  these 
accounts  for  such  fixed  assets  as  are  necessary  for  a  retail  business 
such  as  that  of  W.  A.  Williams  will  be  discussed  below. 

Office  Furniture  or  Equipment.  Under  this  heading  is  included 
the  property  purchased  for  use  in  the  office  of  a  business,  such  as 
desks,  typewriters,  safes,  filing  cabinets,  bookcases,  chairs,  tables,  etc. 
In  a  small  business,  counters,  show  cases,  etc.,  may  be  included  under 
this  heading,  though  in  most  cases  a  separate  account  called  "store 
fixtures  "  is  kept  with  such  property. 

It  has  been  explained  that  two  accounts  may  be  kept  with  such 
property,  one  with  the  asset  itself  and  one  to  show  the  amount  by 
which  the  asset  has  depreciated.  The  purpose  of  the  office  furniture 
account  is  to  show  the  cost  of  such  equipment  purchased,  the  cost  of 
the  equipment  disposed  of  or  no  longer  used  in  the  business,  and 
the  balance,  which  represents  the  cost  of  theye^uipment  employed 
in  the  conduct  of  the  business. 


74 


PRINCIPLES  OF  ACCOUNTING 


The  debits  and  credits  to  this  account  are  as  follows: 
FURNITURE  AND  FIXTURES 


Debit: 

With  the  cost  value  of  furniture  and 
fixtures  purchased. 


Credit: 

With  the  cost  value  of  furniture  and 
fixtures  sold,  exchanged, destroyed, 
or  discarded. 


The  balance  of  this  account  shows  the  cost  value  of  the  furniture  and 
fixtures  used  in  the  conduct  of  the  business  and  is  shown  as  a  fixed 
asset  on  the  balance  sheet. 

Reserve  for  Depreciation  of  Office  Furniture.  The  purpose  of  the 
reserve  for  depreciation  of  furniture  and  fixtures  account  is  to  show 
the  net  amount  of  the  reserve  created  to  take  care  of  the  decrease  in 
value  of  the  property  used  in  the  office. 

The  debits  and  credits  to  this  account  are  as  follows: 

RESERVE  FOR  DEPRECIATION  OF  FURNITURE  AND  FIXTURES 


Debit: 
With  the  cost  value  of  furniture  and 

fixtures  discarded  or  destroyed. 
With  the  excess  of  the  cost  over  the 

selling  price  of  furniture  and  fixtures 

sold. 


Credit: 

At  the  close  of  each  fiscal  period  with 
the  amount  of  depreciation  of  the 
furniture  and  fixtures  which  is 
estimated  to  be  properly  charge- 
able against  that  period's  oper- 
ations. 


After  adjustment  at  the  end  of  a  period,  the  balance  of  this 
account  shows  the  total  amount  which  has  been  charged  against 
revenue  up  to  date  for  depreciation  on  the  furniture  and  fixtures  which 
are  still  in  use.  The  balance  should  appear  on  the  balance  sheet  as  a 
deduction  from  the  furniture  and  fixtures  account.  In  case  of  the 
loss  of  a  fixed  asset  through  accident,  such  loss  not  properly  falling 
under  the  head  of  depreciation,  the  asset  account  would  be  credited 
for  the  cost  of  the  property  destroyed,  and  the  reserve  for  depreciation 
account  would  be  debited  with  an  amount  representing  the  estimated 
accrued  depreciation  on  the  property  to  date.  The  difference  be- 
tween the  cost  of  the  asset  and  the  accrued  depreciation  would  be 
debited  to  a  special  account,  such  as  "  Loss  from  Fire." 

If  an  account  is  kept  with  store  fixtures,  it  will  be  necessary  to 
keep  also  a  reserve  ftr  depreciation  of  store  fixtures  account.  The 
principles  governing  the  construction  of  these  accounts  and  the  treat- 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS   75 


ment  of  their  balances  are  exactly  the  same  as  hi  the  case  of  furniture 
and  fixtures.  It  is  accordingly  not  necessary  to  give  a  discussion 
of  them  here. 

Delivery  Equipment.  The  purpose  of  the  account  with  delivery 
equipment  is  to  show  the  cost  of  property  purchased  for  use  in  deliver- 
ing goods.  This  includes  cost  of  teams,  wagons,  harness,  automobiles, 
or  any  other  conveyances  that  may  be  used  by  the  business  in  deliver- 
ing goods  to  customers.  Cost  of  repairs  to  delivery  equipment  must 
not  be  charged  to  this  account,  but  to  the  delivery  expense  account. 

The  debits  and  credits  to  this  account  are  as  follows: 

DELIVERY  EQUIPMENT 


Debit: 

With  cost  of  property  purchased  for  use 
in  delivering  goods  to  customers. 


Credit: 

With  the  cost  price  of  any  property 
sold  or  discarded  which  has  pre- 
viously been  charged  to  this 
account. 


The  balance  of  this  account  shows  the  cost  value  of  the  delivery 
equipment  on  hand.  It  is  shown  as  a  fixed  asset  on  the  balance  sheet. 

Reserve  for  Depreciation  of  Delivery  Equipment.  As  with  other 
fixed  assets,  it  may  be  desirable  to  keep  two  accounts  with  delivery 
equipment.  The  first,  as  explained  and  illustrated  above,  shows  the 
cost  of  the  asset.  The  second,  as  explained  and  illustrated  below, 
records  the  estimated  amount  of  the  depreciation  which  has  resulted 
from  the  use  of  the  asset  in  the  business. 

The  purpose  of  the  reserve  for  depreciation  of  delivery  equipment 
account  is  to  show  the  net  amount  of  the  estimated  decrease  in  value 
of  the  property  purchased  for  delivery  purposes. 

The  debits  and  credits  to  this  account  are  as  follows: 

RESERVE  FOR  DEPRECIATION  OF  DELIVERY  EQUIPMENT 


Debit: 

With  the  cost  price  of  delivery  equip- 
ment discarded. 

With  the  excess  of  the  cost  over  the 
selling  price  of  delivery  equipment 
sold. 


Credit: 

At  the  close  of  each  fiscal  period  with 
the  estimated  depreciation  of  de- 
livery equipment  charged  to  the 
operations  of  that  period. 


The  balance  of  this  account  is  shown  on  the  balance  sheet  as  a  deduc- 
tion from  the  amount  of  the  delivery  equipment  account.    It  represents 


76 


PRINCIPLES  OF  ACCOUNTING 


the  amount  which  has  been  charged  off  to  date  for  depreciation  on 
such  of  this  class  of  property  as  is  still  in  use  in  the  business. 

Accounts  with  proprietorship.  In  the  preceding  chapters  it  has 
been  repeatedly  emphasized  that  proprietorship  is  the  excess  of  the 
total  assets  of  a  business  over  its  total  liabilities,  or  the  owner's  net 
investment  in  the  business.  The  amount  of  this  net  worth  can  be 
obtained  at  any  time  by  taking  the  difference  between  the  total 
assets  and  total  liabilities.  But,  as  has  been  pointed  out  previously, 
it  is  customary  to  maintain  at  all  times  a  balance  between  the  total 
of  the  debits  and  of  the  credits.  For  this  reason  accounts  are  kept 
with  proprietorship.  An  account  is  maintained  which  shows  the 
amount  of  the  original  investment  made  by  the  proprietor,  all  addi- 
tions to  that  investment,  and  all  subtractions  from  it.  Also  at  the 
end  of  each  fiscal  period  the  net  profit  or  loss  of  the  business  for  the 
period  is  added  to  or  subtracted  from  the  figure  of  the  net  investment 
shown  by  the  account,  which  then  reflects  the  status  of  the  proprietor's 
net  interest  at  that  time.  This  account  is  usually  known  as  the 
proprietor's  "capital"  account. 

Debits  and  credits  will  be  made  to  this  account  as  follows: 

PROPRIETOR'S  CAPITAL  ACCOUNT 


Debit: 

With  all  withdrawals  of  investment. 
With  the  net  loss  for  the  accounting 
period. 


Credit: 

With  the  amount  of  the  proprietor's 
original  investment. 

With  all  additions  made  to  that 
investment. 

With  the  net  profit  for  the  account- 
ing period. 


So  long  as  the  owner  has  any  proprietorship  in  the  business,  this 
account  will  always  show  a  credit  balance.  If  it  should  happen  that 
the  liabilities  of  the  business  are  in  excess  of  the  assets,  the  business 
is  insolvent  and  normally  would  not  continue  to  operate.  When 
such  a  condition  exists,  the  balance  in  the  proprietor's  capital  account 
will  appear  on  the  debit  side  and  show  the  amount  of  the  discrepancy 
between  assets  and  liabilities,  that  is,  the  amount  of  the  deficit.  The 
credit  balance  which  normally  appears  in  this  account  is  shown  on  the 
balance  sheet,  being  added  to  the  total  of  the  liabilities,  the  total  of 
liabilities  and  proprietorship  being  equal  in  amount  to  the  total  of 
assets. 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS        77 


In  a  business  with  a  single  proprietor,  it  is  customary  to  keep  an 
account  showing  the  amount  of  the  drawings  of  the  owner  and  the 
amount  that  is  supposed  to  be  subject  to  his  withdrawal,  according 
to  the  plans  of  the  business.  Such  an  account  is  known  as  the  pro- 
prietor's "personal"  account.  It  is  supposed  to  reflect  the  amounts 
which  the  proprietor  draws  during  the  fiscal  period  for  his  personal 
needs  and  in  anticipation  of  the  period's  profits.  As  already  shown, 
any  withdrawals  intended  to  reduce  permanently  the  original  or 
accumulated  investment  will  be  shown,  not  in  this  account,  but  in 
the  capital  account.  In  many  cases  the  proprietor  allows  himself  a 
fixed  salary,  which  may  represent  the  amount  which  he  intends  to 
withdraw  each  period  out  of  profits.  Where  this  scheme  is  followed, 
this  salary  is  charged  as  an  expense  in  the  group  of  administrative 
expenses,  and  the  amount  so  charged  is  credited  to  the  personal 
account  of  the  owner.  In  such  a  case  the  balance  of  the  account 
will  show  at  any  time  whether  the  owner  has  withdrawn  more  or  less 
than  the  amount  of  salary  with  which  he  has  been  credited  up  to  that 
time. 

The  debits  and  credits  to  the  personal  account  are  as  follows: 

PROPRIETOR'S  PERSONAL  ACCOUNT 


Debit: 

With  amounts  drawn  by  the  owner 
against  anticipated  current  profits  or 
salary  allowance. 


Credit: 

With  periodical  allowance  for  salary 
of  the  owner. 


As  stated  above,  this  account  may  show  either  a  debit  or  a  credit 
balance,  depending  on  whether  the  allowance  made  for  the  owner's 
salary  has  been  overdrawn  or  left  partly  undrawn.  In  either  case  the 
balance  of  this  account  must  be  considered  in  conjunction  with  the 
balance  of  the  capital  account  in  order  to  ascertain  the  exact  net 
proprietorship  at  a  given  time.  A  credit  balance  in  the  personal 
account  is  to  be  added  to  the  balance  in  the  capital  account  to  show 
total  proprietorship,  while  a  debit  balance,  representing  an  overdraft, 
or  advance  drawing  against  profits,  is  to  be  deducted.  The  distinction 
between  personal  and  capital  accounts  is  more  important  where  there 
is  more  than  one  owner;  that  is,  in  a  partnership.  There  it  is  impor- 
tant to  know  how  much  each  of  the  owners  is  entitled  to  draw  and 
how  his  drawings  stand  in  relation  to  that  amount  at  any  given  time. 


78  PRINCIPLES  OF  ACCOUNTING 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  You  are  requested  to  examine  the  accounts  of  the  X.Y.  Manufacturing 
Company  to  determine  whether  they  are  maintained  in  such  a  way 
that  they  provide  accurate  and  comprehensive  information  for  the 
accounting  reports.    What  information  would  you  desire  with  reference 
to  each  account  in  order  to  determine  this  ? 

2.  James  King  is  employed  as  bookkeeper  by  the  X.Y.  Manufacturing 
Company.    He  is  unfamiliar  with  the  account  titles  which  they  use. 
What  will  he  need  to  know  with  reference  to  each  account  in  order  to 
perform  his  duties  intelligently  ? 

3.  In  inspecting  the  ledger  of  the  X.Y.  Manufacturing  Company  you  find 
that  the  cash  account  shows  a  credit  balance  of  $100.00.    What  would 
you  infer  from  this  ? 

4.  How  would  you  proceed  to  prove  the  correctness  of  the  balance  of  the 
cash  account  ? 

5.  On  January  i  H.  B.  Jones  owes  the  business  $100.00.     In  response 
to  a  request  for  payment  he  sends  $40.00  in  cash  and  his  thirty-day 
note  for  $60.00.    What  entries  would  be  made  in  the  accounts  when 
the  cash  and  note  are  received  from  Jones  ? 

6.  On  the  ledger  of  the  A.B.  Company  the  account  of  J.  R.  Baker  appears 
as  follows: 

J.  R.  BAKER 


January  i 

80!  oo 

January  12 

80 

oo 

22 

4.o'oo 

4  1 

Is  Baker  a  customer  or  a  creditor  of  the  company  ? 
7.  On  the  same  ledger  the  account  of  T.  W.  Torr  appears  as  follows: 

T.  W.  TORR 


January  10 

76  oo 

January  25 

76 

OO 

Is  Torr  a  creditor  or  a  customer  of  the  company  ? 

8.  On  January  i  H.  R.  DuPont  purchases  delivery  equipment  which  costs 
$3,000.00.    On  December  31  should  this  asset  be  shown  on  the  balance 
sheet  at  cost  ?    If  not,  how  would  you  determine  the  amount  at  which 
it  should  be  shown  ? 

9.  At  the  end  of  the  fiscal  period  your  employer  estimates  that  his  office 
furniture  has  depreciated  during  the  year  to  the  amount  of  $40.00. 
In  what  way  would  you  treat  this  depreciation  in  making  a  balance 
sheet  ?    How  would  it  be  treated  on  the  statement  of  profit  and  loss  ? 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS        79 

10.  How  is  depreciation  on  fixed  assets  shown  in  the  accounts  ? 

11.  The  following  transactions  were  performed  by  James  Monroe,  single 
proprietor: 

Jan.     i.  Invests  $2,000.00  in  cash. 

Feb.     3.  Makes  an  additional  investment  of  $200.00. 

Mar.    i.  Withdraws  $50.00  for  personal  use. 

June    i.  Withdraws  $70.00  for  personal  use. 

July     2.  Makes  an  additional  investment  of  $1,500.00. 

Sept.  30.  Decides  to  reduce  his  investment  and  withdraws  $1000.00. 

Oct.     i.  Withdraws  $80.00  for  personal  use. 

Dec.  31.  Determines  from  his  statement  of  profit  and  loss  that  his 

profits  for  the  year  are  $800.00. 

Explain  how  the  above  transactions  would  be  shown  in  the  proprietor's 
capital  and  personal  accounts. 

REFERENCES  FOR  FURTHER  STUDY 

SPRAGUE,  CHARLES  E.,  Philosophy  of  Accounts,  chaps,  vi,  vii,  viii,  ix. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  xi. 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  xii,  xiii. 
STOCKWELL,  H.  G.,  Net  Worth  and  the  Balance  Sheet. 

LABORATORY  EXERCISE  NO.  11 
ILLUSTRATION  OF  BALANCE  SHEET  ACCOUNTS 

On  January  i,  1919,  you  are  employed  as  bookkeeper  by  G.  T.  Davies. 
Mr.  Davies'  accounting  system  consists  of  only  memorandum  records. 
You  find  it  necessary  to  open  new  records  for  him.  With  his  aid  you  deter- 
mine that  his  assets  and  liabilities  are  as  follows: 

Cash -.       .      $1,300.00 

Notes  receivable       .       .       .       .       .       .       .       .  40.00 

Accounts  receivable 3,800.00 

Merchandise  inventory 3,200.00 

Office  furniture 450.00 

Building 2,000.00 

Land 1,000.00 

Notes  payable 1,300.00 

Accounts  payable 2,700.00 

Instructions: 

On  ledger  paper  open  the  accounts  necessary  to  show  the  financial  con- 
dition of  Mr.  Davies  on  January  i,  1919.  Allow  ten  lines  for  each  account. 


8o  PRINCIPLES  OF  ACCOUNTING 

LABORATORY  EXERCISE  NO.  12 
ILLUSTRATION  OF  BALANCE  SHEET  ACCOUNTS 

During  the  month  of  January,  Davies  performs  the  following  trans- 
actions : 

Jan.    i.  Receives  cash  from  customers  to  apply  on  account,  $320.00. 

2.  Pays  for  the  erection  of  an  additional  room  to  the  building, 
$800.00. 

3.  Receives  from  customers  to  apply  on  account,  $240.00. 

4.  Receives  a  note  from  a  customer  to  apply  on  account,  $80.00. 
6.  Pays  creditors  to  apply  on  account,  $120.00. 

10.  Withdraws  for  private  use,  $60.00. 

12.  Purchases  a  desk  for  office  use,  $65.00. 

14.  Gives  a  thirty-day  note  for  $110.00  to  a  creditor  to  apply  on 

account. 

1 6.  Receives  $60.00  in  payment  of  a  note  due  from  a  customer. 
20.  Makes  an  additional  cash  investment,  $300.00. 
22.  Pays  a  note  due  to  a  creditor,  $45.00. 

25.  Pays  creditors  to  apply  on  account,  $240.00. 

26.  Receives  from  customers  to  apply  on  account,  $200.00. 
28.  Withdraws  for  private  use,  $80.00. 

30.  Reduces  his  investment   in   the   business  by   withdrawing 
$300.00  in  cash. 

Instructions: 

Make  the  entries  on  the  ledger  which  are  necessary  to  record  these 
transactions. 

Preserve  this  exercise  for  future  use. 


CHAPTER  VII 

THE  CONSTRUCTION  AND  INTERPRETATION 
OF  ACCOUNTS— Concluded 

Accounts  with  merchandise.  Merchandise  is  a  general  term  applied 
to  goods  bought  and  sold  by  a  mercantile  business,  such  as  groceries, 
dry  goods,  hardware,  etc.  In  accounting,  merchandise  bought  is 
termed  "purchases,"  merchandise  sold  is  termed  "sales,"  and  the 
merchandise  on  hand  at  the  beginning  or  end  of  a  fiscal  period  is 
termed  "merchandise  inventory."  It  is  from  the  purchase  and  sale 
of  merchandise  that  the  owner  of  a  mercantile  business  expects  to 
derive  his  profit,  and  most  of  the  current  transactions  which  such  a 
business  performs  pertain  to  purchases  and  sales. 

By  referring  to  the  statement  of  profit  and  loss  given  in  chapter 
iv,  it  will  be  seen  that  sales,  purchases,  and  inventory  are  shown  as 
separate  items,  therefore  there  must  be  some  means  by  which  the 
amount  of  each  can  be  obtained  at  the  end  of  the  fiscal  period.  The 
amount  of  the  purchases  and  sales  for  the  period  are  obtained  from 
the  ledger  accounts  which  are  kept  for  the  purpose.  The  inventory  of 
merchandise  is  usually  obtained  by  making  a  physical  count  of  the 
goods  in  stock,  and  determining  their  value  at  cost  price.  At  the  end 
of  the  fiscal  period,  after  the  amount  of  the  inventory  is  thus  deter- 
mined, it  is  customary  to  open  an  account  to  record  its  amount. 
The  present  discussion  will  be  confined  to  a  consideration  of  the  ac- 
counts with  purchases,  sales,  and  inventory.  In  subsequent  chapters 
the  use  of  other  accounts  to  provide  more  detailed  information 
concerning  merchandise  will  be  discussed. 

The  purchases  account.  The  use  of  the  purchases  account  is 
peculiar  to  mercantile  concerns.  Its  purpose  is  to  show  the  cost  of 
goods  purchased.  Only  purchases  of  goods  intended  for  resale  are 
recorded  in  this  account.  Purchases  of  fixed  assets,  of  raw  materials 
for  manufacturing,  or  of  miscellaneous  supplies,  such  as  pens,  paper, 
clips,  etc.,  must  be  recorded  in  separate  accounts. 

81 


8a 


PRINCIPLES  OF  ACCOUNTING 


The  debits  and  credits  to  the  purchases  account  are  as  follows: 
PURCHASES 


Debit: 
With  the  invoice  price  of  merchandise 

purchased. 
With  the  amounts  paid  for  freight  and 

drayage  on  merchandise  purchased, 

if  a  separate  account  is  not  kept  with 

these  items. 


Credit: 

Allowances  and  deductions  are  some- 
tunes  credited  to  this  account,  but 
it  is  better  to  have  a  separate 
account  for  them,  as  will  be  ex- 
plained later. 


The  balance  of  this  account  shows  the  cost  of  goods  purchased  and 
is  shown  on  the  statement  of  profit  and  loss  as  an  item  of  cost  of  goods 
sold. 

The  sales  account.  The  purpose  of  the  sales  account  is  to  show  the 
amounts  received  from  the  sale  of  merchandise,  manufactured  product, 
or  services,  as  the  case  may  be.  For  the  present,  the  discussion  will 
be  confined  to  mercantile  businesses,  and  only  sales  of  merchandise 
will  be  considered. 

The  debits  and  credits  to  this  account  are  as  follows: 

SALES 


Debit: 

Allowances  and  deductions  to  custom- 
ers are  sometimes  debited  to  this 
account,  but  it  is  better  to  have  a 
separate  account,  as  will  be  explained 
later. 


Credit: 

With  the  selling  price  of  merchandise 
sold. 


The  balance  of  this  account  shows  the  amount  of  sales  made  during 
the  fiscal  period  and  is  shown  as  the  principal  item  of  income  on  the 
statement  of  profit  and  loss. 

The  inventory  account.  Entries  are  made  in  the  inventory  account 
only  at  the  end  of  the  fiscal  period.  Its  construction  and  use  may  be 
better  explained,  therefore,  hi  connection  with  the  discussion  of  the 
summary  of  operations  at  the  end  of  the  fiscal  period.  Consequently 
the  discussion  of  this  account  will  be  postponed  until  the  following 
chapter. 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS       83 

A  ccounts  with  operating  expenses.  As  previously  stated,  the  nature 
and  the  amount  of  the  operating  expenses  are  determined  in  the  main 
by  the  size,  nature,  and  organization  of  the  business.  In  turn,  the 
nature  and  amount  of  the  expenses  determine  to  a  considerable 
extent  their  sub-classifications  and  the  accounts  which  are  kept  to 
record  them.  In  deciding  what  accounts  should  be  kept  with  ex- 
penses it  should  always  be  remembered  that,  although  it  is  important 
to  have  information  which  will  show  what  the  expenses  have  been  for  a 
certain  period,  it  is  equally  important  to  have  information  which  will 
make  possible  plans  for  the  reduction  of  expenses  during  succeeding 
periods. 

Usually  the  operations  of  a  business  are  capable  of  a  more  or  less 
definite  classification.  For  instance,  the  operations  of  a  mercantile 
business  may  be  classified  as  follows:  purchasing  goods;  selling  goods; 
transporting  and  delivering  goods;  and  administering  the  business  as 
a  whole.  Of  course,  each  of  these  classes  of  operations  is  capable  of 
considerable  subdivision,  but  they  indicate  fairly  well  the  operations 
of  a  business  of  average  size.  The  expenses  of  a  mercantile  business 
may  accordingly  be  classified  as  follows:  (i)  buying  expenses;  (2) 
selling  expenses;  (3)  drayage  and  delivery  expenses;  (4)  administrative 
expenses. 

If  such  a  classification  is  used,  there  must  be  at  least  one  account 
with  each  class.  Of  course  there  may  be  several  accounts  kept  with 
each  of  these  divisions.  For  the  sake  of  simplicity  it  will  be  assumed 
that  only  one  account  will  be  kept  with  each  class  of  expense.  The 
more  detailed  accounts  will  be  introduced  later. 

Buying  expenses.  The  purpose  of  the  account  with  buying 
expenses  is  to  show  the  expenses  incurred  in  the  purchase  of  merchan- 
dise. In  a  store  which  does  not  have  one  or  more  buyers  to  devote 
their  entire  time  to  the  purchase  of  merchandise,  this  function  may 
be  performed  by  the  owner,  manager,  or  other  executive  of  the  busi- 
ness. In  this  case  the  proportionate  part  of  the  salary  of  the  person 
who  performs  the  duties  of  the  buyer  may  be  treated  as  a  buying 
expense.  Similarly,  the  estimated  number  of  hours  a  week  given  by 
any  member  or  members  of  the  office  force  to  buying  may  be  charged 
to  this  account.  This  account  should  also  be  charged  with  traveling 
expenses  of  buying  trips  and  other  miscellaneous  buying  expenses. 


84 


PRINCIPLES  OF  ACCOUNTING 


The  debits  and  credits  to  this  account  are  as  follows: 
BUYING  EXPENSES 


Debit: 

With  all  expenses  incurred  in  the  pur- 
chase of  merchandise. 


Credit: 

With  any  adjustments  which  reduce 
the  amounts  debited  to  this 
account. 


The  balance  of  this  account  shows  the  expenses  incurred  in  the  pur- 
chase of  merchandise  and  is  shown  hi  the  statement  of  profit  and  loss 
as  an  operating  expense. 

Selling  expenses.  The  purpose  of  the  account  with  selling  expenses 
is  to  show  the  expenses  incurred  in  the  sale  of  merchandise.  The 
wages  and  other  remunerations  of  sales  persons,  order  takers,  and  all 
others  engaged  in  selling  should  be  treated  as  selling  expense.  If  it 
is  the  duty  of  some  executive  to  supervise  the  sales  department  of  the 
business,  his  salary  should  also  be  charged  to  this  account.  Expendi- 
tures for  advertising  purposes  such  as  space  in  newspapers,  periodicals; 
space  on  the  street  cars  and  billboards;  circulars  and  postage  thereon; 
advertising  novelties;  charitable  donations;  window  display,  etc., 
should  be  treated  as  a  part  of  selling  expense.  Such  expenses  may  be 
charged  to  an  advertising  account,  but  if  so,  they  should  be  added  to 
the  other  selling  expenses  hi  arriving  at  the  total  sales  expense  of  the 
business.  In  addition  to  the  above,  the  cost  of  wrapping  paper, 
cartons,  twine,  salesmen's  order  books,  and  all  other  items  of  direct 
selling  expense  should  be  charged  to  this  account. 

The  debits  and  credits  to  this  account  are  as  follows: 

SELLING  EXPENSES 


Debit: 

All  expenses  incurred  in   connection 
with  the  sales  of  merchandise. 


Credit: 

With  any  adjustments  which  reduce 
the  amount  of  the  charges  made  to 
this  account. 


The  balance  of  this  account  shows  the  expenses  incurred  in  the  sale 
of  merchandise  and  is  shown  in  the  statement  of  profit  and  loss  as  an 
operating  expense. 

Accounts  with  delivery  expense  and  dray  age  expense.    In  every 
mercantile  business  there  are  certain  expenses  incurred  in  connection 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS       85 

with  the  local  transportation  of  merchandise.  In  a  retail  business  the 
goods  purchased  must  be  transported  from  the  railroad  depot  to  the 
storeroom  of  the  business.  Such  transportation  may  be  performed 
by  the  business  itself  or  it  may  employ  others  to  do  it.  In  either  case 
certain  expenses  are  incurred.  These  expenses — usually  known  as 
drayage — constitute  a  part  of  the  cost  of  the  merchandise  and  are 
added  to  the  invoice  price  in  arriving  at  the  cost  of  the  goods  sold. 

Then,  too,  a  retail  business  usually  incurs  certain  expenses  in 
connection  with  the  delivery  of  goods  sold  to  customers.  This  expen- 
diture constitutes  an  operating  expense  and  may  be  shown  on  the 
accounting  reports  as  a  separate  item  or  as  a  subdivision  of  selling 
expense. 

In  a  wholesale  business  certain  expenses  are  incurred  in  connection 
with  transporting  merchandise  from  the  railroad  depot  to  the  ware- 
house of  the  business.  As  in  the  case  of  the  retail  business,  these 
expenses — known  as  drayage  expenses — constitute  a  part  of  the  cost 
of  the  goods  purchased.  The  wholesale  company  also  incurs  expenses 
in  connection  with  transporting  goods  sold  from  its  warehouse  to  the 
railroad  depot.  As  in  the  case  of  the  delivery  expenses  hi  the  retail 
business,  these  expenses — by  whatever  name  known — constitute  a 
selling  expense.  Sometimes  the  wholesale  company  uses  the  same 
equipment  to  deliver  goods  to  the  depot  and  bring  goods  from  the 
depot,  in  which  case,  it  may  be  impracticable  to  attempt  to  keep  the 
cost  of  these  two  services  separately.  In  this  case  the  total  cost  is 
recorded  in  one  account  and  at  the  end  of  the  period  it  is  allocated  on 
some  rational  basis  between  the  cost  of  goods  purchased  and  selling 
expense. 

In  the  following  discussion,  the  term  "delivery  expense"  will  be 
used  to  refer  to  the  cost  of  delivering  goods  sold,  whether  these  goods 
are  delivered  directly  to  the  purchasers,  as  in  the  case  of  the  retail 
business,  or  only  to  the  railroad  depot,  as  in  the  case  of  the  wholesale 
business. 

The  purpose  of  the  account  with  delivery  expense  is  to  show  the 
cost  of  delivering  merchandise  to  customers.  Wages  of  employees 
engaged  in  delivering  the  goods  should  be  treated  as  delivery  expense. 
In  addition,  all  stable  and  garage  expenses,  also  all  repairs,  licenses, 
upkeep,  and  depreciation  of  delivery  equipment  should  be  charged 
to  this  account. 


86 


PRINCIPLES  OF  ACCOUNTING 


The  debits  and  credits  to  this  account  are  as  follows: 
DELIVERY  EXPENSE 


Debit: 

All  expense  incurred  in  connection  with 
the  delivery  of  merchandise. 


Credit: 

With  any  adjustments  which  reduce 
the  amount  debited  to  this 
account. 


The  balance  of  this  account  shows  the  cost  of  delivering  merchandise 
to  customers  and  may  be  shown  in  the  statement  of  profit  and  loss  as  a 
separate  item  under  operating  expense,  or  it  may  be  shown  as  a  sub- 
item  under  selling  expense. 

Administrative  expenses.  The  purpose  of  the  account  with  ad- 
ministrative expenses  is  to  show  expenses  incurred  in  the  admin- 
istration and  management  of  the  business.  The  various  items  of 
expense  which  may  be  charged  to  this  account  are  too  numerous  to 
mention.  Some  of  the  most  important,  however,  are  salaries  of  the 
manager,  bookkeepers,  office  clerks,  stenographers,  and  general  office 
help  not  otherwise  charged.  The  cost  of  stationery  of  all  sorts, 
account  books,  forms,  typewriter  supplies,  printing,  postage,  and 
depreciation  of  office  equipment,  the  expenses  of  insurance  on  store 
equipment,  as  well  as  taxes  on  the  same;  the  cost  of  heat,  light, 
repairs,  depreciation  on  store  equipment,  and  other  miscellaneous 
items  are  usually  charged  to  administrative  expenses. 

The  debits  and  credits  for  this  account  are  as  follows: 

ADMINISTRATIVE  EXPENSE 


Debit: 

With  all  expenses  incurred  in  connec- 
tion with  the  administration  and 
management  of  the  business. 


Credit: 

With  any  adjustments  which  reduce 
the  amounts  debited  to  this 
account. 


The  balance  of  this  account  shows  the  cost  of  the  administration  and 
management  of  the  business  and  is  shown  as  an  operating  expense  in 
the  statement  of  profit  and  loss. 

Arrangement  of  accounts  in  the  ledgers.  As  explained  in  chapter  v, 
the  accounts  of  a  business  are  arranged  in  systematic  order  in  the 
ledger.  Usually  they  are  arranged  in  the  ledger  in  the  same  order 
in  which  they  appear  on  the  balance  sheet  and  on  the  statement  of 
profit  and  loss.  On  the  balance  sheet  the  items  are  listed  as  follows: 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS       87 

current  assets,  fixed  assets,  current  liabilities,  and  proprietorship. 
In  the  ledger  the  accounts  necessary  to  provide  the  information  from 
which  the  balance  sheet  is  made  are  arranged  in  the  same  order. 
In  the  statement  of  profit  and  loss  the  items  are  as  follows:  sales,  cost 
of  goods  sold,  and  expenses.  In  the  ledger  the  accounts  necessary  to 
obtain  the  amount  of  each  of  these  items  are  arranged  accordingly. 

The  accounts  in  the  ledger  should  always  be  arranged  in  the  same 
order  in  which  they  appear  in  the  balance  sheet  and  the  statement  of 
profit  and  loss.  This  arrangement  facilitates  the  making  of  the 
reports  and  the  comparison  of  the  reports  with  the  accounts. 

Summary.  In  chapter  v  it  has  been  explained  that  the  primary 
function  of  the  account  is  to  provide  a  classified  and  summarized 
record  of  the  information  which  the  owner  needs  in  the  management 
of  his  business.  This  information  he  obtains  by  means  of  reports 
such  as  the  balance  sheet  and  statement  of  profit  and  loss.  The 
accounts  of  a  business  should  provide,  therefore,  the  information 
necessary  to  make  such  reports. 

In  the  present  and  the  preceding  chapter  the  construction  and 
interpretation  of  the  accounts  necessary  to  provide  the  information 
shown  on  the  simple  balance  sheet  and  statement  of  profit  and  loss  of 
W.  A.  Williams  have  been  discussed.  Later,  when  more  compre- 
hensive reports  are  discussed,  it  will  be  seen  that  additional  accounts 
must  be  maintained.  If  the  student  has  mastered  the  principles 
governing  the  use  and  construction  of  the  accounts  discussed  in  these 
two  chapters,  he  will  have  little  difficulty  in  applying  these  principles 
to  the  accounts  which  will  be  discussed  in  subsequent  chapters. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  On  June  i  K.  P.  Spear  had  $2,000.00  of  merchandise  on  hand.     During 
the  month  he  purchased  $5,000.00  of  merchandise  and  sold  $6,000.00. 
How  would  these  facts  be  recorded  in  the  accounts  ? 

2.  How  would  he  determine  the  amount  of  his  merchandise  on  hand  at  the 
end  of  the  month  ? 

3.  J.  P.  Long,  retail  dry  goods  merchant,  makes  the  following  cash 
payments: 

a)  For  dry  goods,  $300.00. 
6)  For  repairs  to  delivery  truck,  $20.00. 
c)  For  services  of  delivery  driver,  $40.00. 
cf)  For  wrapping  paper  and  twine,  $15.00. 
e)  For  an  adding  machine,  $250.00. 
How  would  these  transactions  be  recorded  in  his  accounts  ? 


88 


PRINCIPLES  OF  ACCOUNTING 


What  information  is  required  in  order  that  the  cost  of  goods  sold  may 
be  shown  on  the  statement  of  profit  and  loss?  Explain  how  this 
information  is  obtained. 

You  are  employed  by  the  Jones  Company  as  general  manager.  You 
find  by  an  inspection  of  the  accounting  reports  submitted  by  the  book- 
keeper that  all  the  expenses  of  the  business  are  recorded  in  one  expense 
account  termed  "miscellaneous  expense."  As  general  manager  should 
you  regard  this  method  desirable  ?  Why  ? 

What  basis  or  system  would  you  instruct  the  bookkeeper  to  use  in 
recording  the  expenses  ? 

The  following  represents  the  "miscellaneous  expense"  account  of  the 
Jones  Company  for  the  first  eight  days  of  July: 

MISCELLANEOUS  EXPENSE 


Tulv  i 

Sales  salaries      

2C 

oo 

8 

oo 

2 

Janitor  

1C 

oo 

Rent  for  month  .-  

80 

oo 

Wrapping  paper       

A 

oo 

I 

Newspaper  advertising  

8 

no 

10 

no 

Repairs  to  store  fixtures  

6 

Handbills  printed  

6 

60 

Paid  boys  to  distribute  handbills  

A. 

oo 

6 

Sales  salaries    

?O 

oo 

Errand  boy     

6 

oo 

T8 

oo 

Light  bill  

A 

Tl 

Gas  bill  

6 

ilO 

8 

Repairs  on  typewriter  

oo 

Stationery  for  office      

10 

oo 

Repairs  to  building  

12 

oo 

Making  any  assumptions  you  deem  necessary,   what  classification 
should  you  instruct  the  bookkeeper  to  make  of  these  expenses  ? 
8.  The  expenses  of  A.  S.  Joesting,  retail  merchant,  during  the  month  of 
August  as  shown  by  his  check  stubs  are  as  follows: 

1.  Salaries  of  sales  clerks 

2.  Salary  of  stenographer 

Office  boy 

Repairs  on  delivery  truck     .... 
Gasoline  for  delivery  truck  .... 


3- 
4- 
5- 
6.  Repairs  on  typewriter 


$120. oo 
20.00 
36.00 
10.00 
4.70 
1.90 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS       89 

7.  Traveling  expenses  of  Joesting  on  buying  trip  .     $  42. 70 

8.  Repairs  on  adding  machine 2 . 40 

9.  Telephone  bill 6.40 

10.  Telegrams  and  long  distance  calls  in  purchasing 

goods 7.40 

11.  Repairs  on  office  furniture  and  fixtures      .     -.  2.80 

12.  Gasoline  for  delivery  truck 2.90 

13.  Salaries  of  sales  clerks 200.00 

14.  Salary  of  delivery  man 32.00 

15.  Gasoline  for  delivery  truck  .       .       .       .       .  2.70 

16.  Advertising  circulars 20.00 

17.  Paid  for  distributing  circulars      .       .    ^^       .  9.00 

18.  Salary  of  stenographer 20.00 

19.  Janitor 15.00 

20.  Errand  boy  (sales) 2 . 40 

21.  Light  for  store 6.40 

22.  Commissions  of  sales  clerks 40.00 

23.  Gasoline  for  delivery  truck 2.80 

24.  Salaries  of  sales  clerks 200.00 

25.  Delivery  driver 34. oo 

26.  Office  boy 16.00 

27.  Rent 80.00 

You  decide  that  Mr.  Joesting  should  have  his  expenses  classified  under 
the  following  heads: 

a)  Buying  expense 

b)  Selling  expense 

c)  Delivery  expense 

d)  Administrative  expense 

Show  how  the  foregoing  expenses  would  be  classified  under  these  four 
heads. 

9.  J.  M.  Jones  is  a  retail  merchant,  H.  P.  King  is  a  manfacturer,  and 
J.  H.  Bishop  is  a  lawyer.  Would  their  expenses  be  classified  in  the 
same  manner  ?  Why  ? 

10.  State  the  proper  arrangement  of  accounts  in  the  ledger  and  the  reasons 
for  such  an  arrangement. 

REFERENCES  FOR  FURTHER  STUDY 

SPRAGUE,  CHARLES  E.,  Philosophy  of  Accounts,  chap.  xii. 
KESTER,  ROY  B.,  Account  ing  Theory  and  Practice,  Vol.  I,  chap.  xiv. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  x. 


PRINCIPLES  OF  ACCOUNTING 


LABORATORY  EXERCISE  NO.  13 

ILLUSTRATIONS  OF  CLASSIFICATION  OF  TRANSACTIONS 
BY  MEANS  OF  ACCOUNTS 

The  following  transactions  are  to  be  recorded  in  the  ledger.  Be  careful 
to  make  the  proper  debit  and  credit  for  each  transaction.  Set  up  in  the 
ledger  (loose  ledger  sheets)  the  following  accounts  on  the  pages  indicated: 


Cash    . 

Notes  Receivable 
F.  M.  Jones 
Martin  Hotel     . 
Congress  Hotel  . 
M.  J.  Torr 
B.  K.  Shaeffer  . 
M.  M.  McGee  . 
J.  J.  Reighard   . 
J.  W.  Baker       . 


2 
2 
»*       .          .          2 

.         3 

.       .       .       3 
.       3 
4 
4 
Inventory  .       .       .       ...       5 

Office  Furniture.       ...       5 

Ames  &  Co.  6 


French  Bros 6 

Meyer  &  King         ...  6 

H.  P.  Johnson  ....  7 

J.  A.  McCoy  &  Co.        .  7 

Gartman  Bros.        ...  7 

J.  B.  Moseley,  Proprietor      .  8 

J.  B.  Moseley,  Personal.       .  8 

Sales 9 

Purchases         9 

Selling  Expense  10 

Administrative  Expense.       .  10 

Buying  Expense  10 


June    i.  J.  B.  Moseley  invests  $3,000.00  in  the  retail  store  business. 

2.  Bought  of  Ames  &  Co.  on  account,  merchandise,  $82.50. 

3.  Bought  of  French  Bros,  on  account,  merchandise,  $128.60. 

4.  Paid  rent  for  the  month,  $40.00. 

5.  Sold  F.  M.  Jones  on  account,  merchandise,  $18.40. 
Bought  of  J.  A.  McCoy  &  Co.  for  cash,  merchandise,  $198.00. 

6.  Received  for  sundry  cash  sales  to  date,  $30.00. 
Paid  Ames  &  Co.  in  full  of  account,  $82.50. 

8.  Sold  Martin  Hotel  on  account,  merchandise,  $62.40. 
Paid  salary  of  sales  clerk,  $24.00. 

9.  Received  $10.00  from  F.  M.  Jones  to  apply  on  account. 

10.  Bought  of  Meyer  &  King  on  account,  merchandise,  $230.40. 

11.  Paid  as  expenses  of  a  buying  trip,  $43.00. 

Sold  F.  M.  Jones  on  account,  merchandise,  $64.20. 

12.  Received  from  the  Martin  Hotel  to  apply  on  account,  $30.00. 

13.  Received  $60.00  for  sundry  cash  sales  to  date. 
Paid  French  Bros.  $128.60  to  apply  on  account. 

14.  Sold  J.  W.  Baker  on  account,  merchandise,  $46.80. 
Paid  salary  of  sales  clerk,  $24.00. 

15.  Bought  of  Ames  &  Co.  on  account,  merchandise,  $256.00. 

16.  Sold  Congress  Hotel  on  account,  merchandise,  $69.40. 


CONSTRUCTION  AND  INTERPRETATION  OF  ACCOUNTS   QI 

17.  Bought  of  H.  P.  Johnson  on  account,  merchandise,  $34.00. 

18.  Received  of  J.  W.  Baker  $36.00  to  apply  on  account. 
Paid  O.  M.  Haines  $100.00  for  office  furniture. 

19.  Sold  M.  J.  Torr  on  account,  merchandise,  $48.50. 

21.  Received  $50.00  for  sundry  cash  sales  to  date. 

22.  Sold  B.  K.  Shaeffer  on  account,  merchandise,  $28.40. 

23.  Bought  of  J.  A.  McCoy  &  Co.  on  account,  merchandise, 

$187.40. 

24.  Received  from  the  Martin  Hotel  in  part  payment  of  amount 

due,  $15.00. 
Paid  Meyer  &  King  $180.00  to  apply  on  account. 

25.  Sold  Martin  Hotel  on  account,  merchandise  $70.40. 

26.  Received  of  F.  M.  Jones  $8.40  to  apply  on  account. 
Sold  M.  M.  McGee  on  account,  merchandise,  $60.40. 

27.  Sold  J.  J.  Reighard  on  account,  merchandise,  $62.25. 

28.  Received  $48.50  for  sundry  cash  sales. 

Bought  of  Gartman  Bros,  on  account,  merchandise,  $180.60. 

29.  Received  $50.00  from  M.  M.  McGee  to  apply  on  account. 

30.  Paid  Ames  &  Co.  $150.00  to  apply  on  account. 

Paid  bookkeeper's  salary,  $60.00;  salary  of  sales  clerk,  $48.00. 
Received  note  for  $48.50  from  M.  J.  Torr  to  apply  on  account. 
Moseley  withdrew  for  private  use,  $40.00. 

Instructions: 

Record  these  transactions  in  the  accounts. 
Preserve  this  exercise  for  future  use. 


CHAPTER  VIII 

THE  TRIAL  BALANCE 

Purpose  of  the  trial  balance.  In  chapters  v,  vi,  and  vii,  the  account 
has  been  discussed  as  a  means  of  making  a  current  record  of  trans- 
actions. A  business  transaction  consists  of  an  exchange  of  equal 
values.  The  values  received  are  termed  debits  and  the  values  sur- 
rendered are  termed  credits.  To  record  a  transaction  one  must  first 
determine  the  debits  and  credits  to  which  it  gives  rise  and  then  record 
these  debits  and  credits  in  the  proper  accounts. 

Since  the  debits  arising  from  each  transaction  are  equal  to  the 
credits  arising  from  the  same  transaction,  it  follows  logically  that, 
if  a  correct  record  is  made  of  any  number  of  transactions,  the  debits 
arising  from  these  transactions  will  equal  the  credits  arising  therefrom. 
In  other  words,  the  debits  recorded  in  the  ledger  should  equal  or 
balance  the  credits  recorded  therein.  In  order  to  see  if  this  is  true, 
it  is  customary  to  make  periodical  tests  of  their  equality.  Such  a 
test  is  known  as  a  trial  balance.  The  purpose  of  the  present  chapter 
is  to  explain  and  illustrate  how  the  trial  balance  is  made. 

Method  of  taking  a  trial  balance.  In  many  of  the  accounts  there 
are  several  debits  and  several  credits.  One  method  of  proving  the 
equality  between  the  total  debits  and  the  total  credits  would  be  to  list 
and  total:  (a)  all  the  debits  recorded  in  all  the  accounts  and  (b~)  all 
the  credits  recorded  in  all  the  accounts,  and  compare  the  two  totals. 
Such  a  procedure,  however,  would  make  the  trial  balance  very  long 
and  inconvenient  for  use  as  a  report.  It  is  customary,  therefore, 
before  making  a  trial  balance  to  go  through  the  ledger  and  total  each 
side,  making  a  notation  of  the  total  in  small  pencil  figures  just  below 
the  last  entry  appearing  on  each  side  of  the  account. 

After  the  totals  of  (a)  the  debits  and  (5)  the  credits  of  each  account 
are  obtained,  the  trial  balance  may  be  made  in  two  ways:  The  first 
method  is  to  list  all  the  debit  totals  and  all  the  credit  totals  and  after 
adding  to  compare  the  total  of  the  former  with  the  total  of  the  latter. 
The  second  method  is  to  subtract  the  total  of  the  debits  of  each  account 
from  the  total  of  the  credits  of  each  account,  or  vice  versa,  and  obtain 

92 


THE  TRIAL  BALANCE 


93 


thereby  the  debit  or  credit  balance  of  the  account.  Then  the  debit 
and  credit  balances  of  all  the  accounts  are  listed  in  the  trial  balance, 
and  if  the  sum  of  the  debit  balances  equals  the  sum  of  the  credit 
balances  it  is  evidence  that  the  debits  and  credits  in  the  ledger  are 
equal.  Either  method  serves  equally  well  to  test  the  equality  of 
debits  and  credits.  The  latter  method  is  more  frequently  used  be- 
cause it  makes  the  trial  balance  more  simple  and  more  usable.  Both 
methods  will  be  illustrated. 

Illustration  of  the  trial  balance.  In  order  to  illustrate  how  the 
trial  balance  is  made,  a  trial  balance  will  be  made  of  the  following 
simple  ledger: 

CASH 


1919 

Jan.    i 
26 

2,000 

42 

00 

oo 

1919 

Jan.  i 

2 

5 
8 
16 

22 
27 
31 
31 

60 
500 
27 
1  2O 
100 
800 

3° 
78 
47 

00 

00 
00 
00 
00 
00 
00 
00 
00 

NOTES  RECEIVABLE 

Jan.  17 

58 

oo 

R.  D.  JAMES 


Jan     3 

•iSJoo 

Jan.  17 

58 

DO 

12 

42  oo 

_  1 

G.  E.  FRAZER 


Jan     ? 

42 

oo 

Jan.  26 

42 

no 

12 

2\ 

oo 

G.  B.  HOBBS 


Jan.    3 
28 


2900 
62  oo 


J.  S.  ADAMS 


Jan. 12 
28 


1800 
3000 


94 


PRINCIPLES  OF  ACCOUNTING 
MERCHANDISE  INVENTORY 


Tan.    i    . 

1,000 

00 

FURNITURE  AND  FIXTURES 

Jan.  16    

IOO 

oo 

NOTES  PAYABLE 

Jan.  24 

I2O  OO 

N.  W.  BARNES 

Jan  22         ...... 

800 

00 

Jan.  2 

20 

SOOOO 
7800 

L. 

S.  LYON 

Jan  24. 

1  20 

oo 

Jan.  15 

20 

1  2O  OO 
Q2  OO 

W.  H.  SPENCER 

Jan.  15 

8000 

J.  H.  BISHOP,  PROPRIETOR 

Jan.    i 

i 

2,OOOOO 
I,OOOOO 

J.  H.  BISHOP,  PERSONAL 

Tan.  27    . 

?o 

oo 

SALES 

s 

Jan.    3 
3 
3 

12 
12 
12 

28 
28 

5800 

42  oo 
29  oo 
42  oo 
23  oo 

1800 

62  oo 
3000 

THE  TRIAL  BALANCE 
PURCHASES 


Jan.  2  800  oo 

2  500  oo 

15  1 20  oo 

15 8000 

20   78  00 

20   Q2  00 

BUYING  EXPENSES 

Jan.    5    27  oo 

SELLING  EXPENSES 

Jan.    8    1 20  oo 

31    78|oo 

ADMINISTRATIVE  EXPENSES 

Jan.    i    60  oo 

31    4700 


First  method.    If  the  total  debits  and  credits  of  each  account  are 
to  be  shown  in  the  trial  balance  it  will  be  as  follows: 

J.  H.  BISHOP 
TRIAL  BALANCE,  JANUARY  31,  1919 


Cash 

Notes  Receivable 

R.  D.  James 

G.  E.  Frazer 

G.  B.  Hobbs 

J.  S.  Adams 

Merchandise  Inventory. . 
Furniture  and  Fixtures  . . 

Notes  Payable 

N.  W.  Barnes 

L.  S.  Lyon 

W.  H.  Spencer 

J.  H.  Bishop,  Proprietor . 
J.  H.  Bishop,  Personal.. . 

Sales 

Purchases 

Buying  Expenses 

Selling  Expenses 

Administrative  Expenses 


2,04200 
5800 

IOOOO 

6S|oo 

QIJOO 

4800 

1,00000 

IOOOO 

80000 

12000 


1,67000 

2700 

19800 

10700 

6,45600 


1,76200 


5800 

4200 


878 

21200 

8000 

3,00000 


30400 


6,456 


96 


PRINCIPLES  OF  ACCOUNTING 


Since  the  trial  balance  shows  that  the  total  of  all  the  debits  in  the 
ledger  is  equal  to  the  total  of  all  the  credits,  the  ledger  is  said  to  be  in 
balance. 

Second  method.  When  the  second  method  is  employed,  only  the 
debit  or  credit  balance  of  each  account  is  shown  on  the  trial  balance. 
In  order  to  show  the  relation  between  the  two  methods,  the  following 
illustration  will  be  given : 

J.  H.  BISHOP 
TRIAL  BALANCE,  JANUARY  31,  1919 


Cash              

2,042 
58 
too 

65 

91 

48 

1,000 

100 

800 

120 

3° 

1,670 

27 
198 
107 

oo 

00 

oo 
oo 
oo 
oo 
oo 

00 
00 

oo 

oo 
oo 

00 
00 
00 

1,762 

58 

42 

120 

878 

212 

80 

3,000 

304 

oo 

oo 
oo 

00 
00 

oo 
oo 
oo 

oo 

280 

58 

42 
23 
91 
48 

1,000 
IOO 

3° 

1,670 
27 
198 

107 

oo 
oo 
oo 
oo 

00 

oo 
oo 
oo 

oo 

oo 
oo 

00 

00 

1  20 

78 

92 

80 
3,000 

304 

oo 

oo 
oo 

00 
00 

00 

Notes  Receivable  

G.  E.  Frazer  

G.  B.  Hobbs  

J.  S.  Adams  

Merchandise  Inventory.  

Furniture  and  Fixtures  

Notes  Payable  

N.  W.  Barnes  

L.  S.  Lyon  

W.  H.  Spencer  

J.  H.  Bishop,  Proprietor  

J.  H.  Bishop,  Personal  

Sales  

Purchases  

Buying  Expenses  

Selling  Expenses  

Administrative  Expenses  

6,456 

oo 

6,456 

oo 

3,674.loo 

3,674 

00 

It  will  be  seen  that  in  the  first  two  columns  the  total  of  the  debits 
and  the  total  of  the  credits  of  each  account  are  shown.  These  two 
columns  show  the  same  results  as  the  trial  balance  given  in  the  pre- 
ceding paragraph.  In  the  last  two  columns  the  debit  or  credit  bal- 
ance of  each  account  is  shown.  The  balance  of  the  account  is  obtained 
by  the  subtraction  of  the  amounts  shown  in  the  first  two  columns, 
wherever  the  account  shows  both  a  debit  and  a  credit  total.  If  the 
account  shows  only  a  debit  or  credit  total,  this  is  carried  over  as  the 
debit  or  credit  balance  of  the  account.  It  can  be  seen  from  this 
illustration  that  the  equality  of  the  debits  and  credits  is  shown  by 
taking  only  the  balance  of  each  account  just  as  well  as  if  the  total  of 
the  debits  and  the  total  of  the  credits  of  each  account  are  taken. 


THE  TRIAL  BALANCE 


97 


From  the  foregoing  illustration  it  can  be  seen  that  the  trial  balance 
of  J.  H.  Bishop,  showing  the  debit  and  credit  balance  of  each  account, 
will  be  as  follows: 

J.  H.  BISHOP 
TRIAL  BALANCE,  JANUARY  31,  1919 


Cash            

280 
58 
42 
23 
9i 
48 
1,000 

IOO 

30 

1,670 

27 
198 
107 

oo 
oo 
oo 
oo 
oo 
oo 
oo 
oo 

oo 

00 

00 

oo 
oo 

1  20 

78 

92 
80 

3,000 

304 

00 
00 
00 

oo 

00 
00 

00 

Notes  Receivable  x.  

R  D  James   

G  E  Frazer  

G  B  Hobbs  

J  S  Adams     

Merchandise  Inventory  

Furniture  and  Fixtures         ...     . 

Notes  Payable  

N  W.  Barnes  

L  S  Lyon  

W.  H.  Spencer  

J  H.  Bishop,  Proprietor  

J  H  Bishop   Personal    . 

Purchases  

Buying  Expenses  

Selling  Expenses  

Administrative  Expenses  

3.674 

oo 

3,674 

The  trial  balance  as  a  report.  As  previously  stated,  the  primary 
purpose  of  the  trial  balance  is  to  prove  the  equality  of  the  debits  and 
credits  recorded  in  the  accounts.  Although  this  is  its  primary 
function,  it  may  serve  other  purposes.  The  accountant  as  a  rule 
uses  the  trial  balance  as  the  basis  of  his  reports.  The  method  of 
doing  this  can  be  explained  better  after  the  working  sheet  has  been 
discussed  in  a  subsequent  chapter.  The  trial  balance  may  also  be  of 
some  value  as  a  report  to  the  owner  or  manager.  In  many  businesses 
it  is- not  thought  feasible  to  make  a  statement  of  profit  and  loss 
monthly.  In  such  cases  a  comparative  monthly  trial  balance  will 
afford  some  useful  information  to  the  business  manager.  It  will 
enable  him  to  compare  the  balance  of  any  given  asset  or  liability 
account  at  the  end  of  a  month  with  its  balance  at  the  end  of  any 
preceding  month  in  the  year.  Also,  the  approximate  amount  of  any 
kind  of  income  or  expense  for  the  current  month  may  be  obtained 
by  subtracting  from  the  present  balance  of  the  account  the  balance  of 
the  month  before.  The  information  obtained  from  this  statement 


98  PRINCIPLES  OF  ACCOUNTING 

is  not  likely  to  be  complete  or  accurate,  but  will  at  least  indicate  to 
the  manager  the  general  trend  of  the  operations  of  the  business. 

REFERENCES  FOR  FURTHER  STUDY 

PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  pp.  151-54. 

MITCHELL,  T.  W.,  Accounting  Principles,  chap.  ix. 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xv. 

LABORATORY  EXERCISE  NO.  14 

The  ledger  of  H.  T.  Jones  on  September  30,  after  one  month's  opera- 
tions, appears  as  follows: 

CASH 


1919 

Sept.    i 
ii 

22 
22 
27 
27 

4,000 
250 

10 
12 
2OO 

16 

oo 

00 

5° 
oo 
oo 
oo 

1919 

Sept.    2 
3 
4 
25 
3° 
3° 

300  oo 

3,000  oo 

25  oo 

600  oo 

IOO  OO 

4.2  OO 

W.  C.  CHAMBERLAIN 

1919 
Sept.   8 
16 

IO 

13 

50 

oo 

1919 
Sept.  22 

10  50 

O.  S.  GLOVER 

1919 
Sept.    8 
16 

12 

2O 

oo 
oo 

1919 
Sept.  22 

12  OO 

H.  G.  MOULTON 

1919 
Sept.   8 

18 

oo 

L.  C.  SORRELL 

1919 
Sept.  1  6 
28 

16 
U 

00 
00 

1919 
Sept.  27 

I6OO 

THE  TRIAL  BALANCE 
MERCHANDISE  INVENTORY 


99 


OFFICE  FURNITURE 

1919 
Sept.    2   

•?oo 

oo 

MINNEAPOLIS  MILLING  COMPANY 

1919 
Sent.  2<;   . 

600 

oo 

1919 

Sept.   5 

60000 

McHENRY  MERCANTILE  COMPANY 

1919 
Sept.  14 

200  oo 

NEW  YORK  WHOLESALE  COMPANY 

1919 

Sent.  30   . 

100 

oo 

1919 
Sept.  20 

25000 

H.  T.  JONES,  PROPRIETOR 

1919 
Sept.    i 

4,000  oo 

SALES 

1919 
Sept.    8 
8 
8 
ii 
16 
16 
16 
27 
28 

1050 

12  OO 
I800 
25OOO 
1300 

16  oo 
20  oo 
200  oo 

v*°° 

100 


PRINCIPLES  OF  ACCOUNTING 
PURCHASES 


1919 
Sept.   3 
5 

14 
20 


3,00000 
60000 

2OO  OO 

25000 


SELLING  EXPENSES 


1919 

Sept     4 

2C 

OO 

ADMINISTRATIVE  EXPENSES 


1919 

Sept.  30 

42 

OO 

Instructions: 

Copy  the  ledger  of  Jones  on  loose  leaf  ledger  paper,  placing  four  ac- 
counts on  each  page. 

Take  a  trial  balance  of  the  ledger  you  have  copied,  showing  only  the 
debit  or  credit  balance  of  each  account. 

LABORATORY  EXERCISE  NO.  15 

On  September  30,  Jones  has  a  merchandise  inventory  of  $3,800.00. 
He  estimates  a  yearly  depreciation  of  10  per  cent  on  office  furniture. 

Make  a  balance  sheet  for  Jones  as  of  September  30  and  a  statement  of 
profit  and  loss  showing  the  result  of  the  operations  for  September. 

Preserve  this  exercise  for  future  use. 

LABORATORY  EXERCISE  NO.  16 

Make  a  trial  balance  of  the  ledger  of  J.  B.  Moseley  prepared  in  Exercise 
No.  13. 

LABORATORY  EXERCISE  NO.  17 

Make  a  trial  balance  of  the  ledger  of  G.  T.  Davies  prepared  in  Exercise 
No.  12. 

LABORATORY  EXERCISE  NO.  18 

The  inventory  of  Moseley  on  June  30  is  $1,000.00.  He  estimates  that 
the  yearly  depreciation  on  his  fixed  assets  is  10  per  cent. 

Make  a  balance  sheet  for  Moseley  as  at  June  30,  and  a  statement  of 
profit  and  loss  showing  results  of  the  operations  for  June. 

Preserve  this  exercise  for  future  use. 


CHAPTER  IX 

THE  ADJUSTING  ENTRIES 

Need  of  adjusting  entries.  A  current  record  of  the  transactions 
which  a  business  performs  is  made  in  the  accounts.  The  making  of 
this  record  involves,  first,  the  analysis  of  the  transactions  to  determine 
the  debits  and  credits  arising  therefrom,  and,  second,  the  recording 
of  these  debits  and  credits  in  the  appropriate  accounts.  The  record 
made  at  the  time  the  transaction  is  performed  shows  the  effect  of  the 
transaction  on  the  financial  condition  of  the  business.  This  effect 
on  the  financial  condition  is  indicated  by  making  certain  changes  in 
the  items  which  will  later  appear  on  the  accounting  reports.  For 
instance,  if  cash  is  paid  for  a  service  which  is  to  be  treated  as  an 
expense,  the  change  in  the  financial  condition  of  the  business  which  is 
produced  by  this  transaction  is  shown  by  subtracting  the  cash  paid 
in  the  cash  account  and  adding  the  service  received  in  some  expense 
account.  So  in  the  case  of  every  transaction  its  effect  on  the  financial 
condition  of  the  business  is  reflected  in  the  accounts. 

There  are,  however,  some  changes  in  financial  conditions  which 
are  not  the  direct  result  of  a  transaction  or  which  cannot  be  recorded 
conveniently  at  the  time  they  take  place.  To  illustrate,  at  the  be- 
ginning of  the  fiscal  period  there  is  certain  merchandise  on  hand. 
Its  amount,  expressed  in  monetary  units,  is  shown  in  a  merchandise 
inventory  account.  During  the  year  additional  merchandise  is 
purchased,  and  merchandise  is  sold.  Consequently  the  amount  of 
merchandise  on  hand  at  any  time  during  the  year  will  in  all  probability 
be  different  from  the  amount  shown  in  the  records.  In  most  mer- 
cantile firms  it  is  not  practicable  to  show  in  the  records  the  daily 
changes  in  the  value  of  the  inventory.  The  usual  method  is  to  wait 
until  the  end  of  the  fiscal  period  and  then  determine  by  count  the 
amount  and  value  of  merchandise  on  hand.  The  amount  of  the  inven- 
tory as  shown  in  the  reports  prepared  at  the  end  of  the  period  must 
be  that  of  the  inventory  taken  at  closing  time.  Therefore  an  entry 
must  be  made  to  correct  the  balance  of  the  inventory  account,  show 
the  amount  of  the  new  inventory,  instead  of  the  old  inventory  balance. 

101 


IO2 


PRINCIPLES  OF  ACCOUNTING 


To  take  another  simple  illustration,  the  fixed  assets  of  the  business 
are  decreasing  in  value  constantly,  due  to  their  use  in  the  business. 
This  decrease  in  value,  however,  cannot  be  recorded  in  the  accounts 
day  by  day  as  it  takes  place.  At  the  end  of  the  fiscal  period,  therefore, 
the  amount  of  the  depreciation  on  fixed  assets  must  be  estimated 
and  entries  made  which  will  show  the  effect  of  such  depreciation  on  the 
financial  condition  of  the  business. 

The  foregoing  are  samples  of  numerous  changes  in  the  financial 
condition  of  the  business  which  take  place  during  the  fiscal  period, 
but  which  cannot  be  conveniently  recorded  until  the  end  of  the  fiscal 
period.  The  entries  made  at  the  end  of  the  fiscal  period  to  give  effect 
to  such  changes  are  known  as  adjusting  entries.  Their  purpose  is  to 
adjust  the  accounts  so  that  these  will  reflect  the  true  financial  con- 
dition of  the  business  and  will  agree  with  the  accounting  reports.  In 
the  present  chapter  such  adjusting  entries  will  be  considered  as 
would  be  used  in  a  simple  business  like  that  of  W.  A.  Williams. 

Merchandise  inventory.  As  previously  stated,  it  is  customary 
in  mercantile  firms  to  ascertain  the  amount  of  the  merchandise  inven- 
tory by  taking  an  actual  count  of  the  goods  on  hand  at  the  end  of  the 
fiscal  period.  These  goods  are  then  priced  at  the  cost  price,  unless 
the  market  price  is  lower  than  cost,  in  which  case  conservative  prac- 
tice dictates  that  they  should  be  evaluated  at  the  lower  price.  The 
value  of  the  inventory  thus  obtained  is  recorded  in  the  account  with 
merchandise  inventory. 

The  purpose  of  the  inventory  account  is,  therefore,  to  show  the 
amount  of  salable  merchandise  on  hand  at  the  end  of  the  fiscal  period 
valued  at  cost  or  market  price,  whichever  is  the  lower. 

The  debits  and  credits  to  this  account  are  as  follows: 

MERCHANDISE  INVENTORY 


Debit: 

At  the  end  of  each  fiscal  period  with  the 
amount  of  the  inventory  taken  at  the 
end  of  that  period.  The  correspond- 
ing credit  is  to  purchases  or  some 
other  account  showing  the  cost  of  the 
goods  sold. 


Credit: 

At  the  end  of  each  fiscal  period  with 
the  amount  of  the  inventory  at  the 
beginning  of  that  period.  (This 
will  be  the  amount  of  the  debit  bal- 
ance in  the  account  previous  to 
the  entry  of  the  new  inventory. 
The  corresponding  debit  will  be  to 
the  purchases  account  or  some 
other  account  designed  to  show  the 
cost  of  goods  sold.) 


THE  ADJUSTING  ENTRIES 


103 


The  balance  of  the  inventory  account  is  always  a  debit  balance,  since 
it  is  an  asset  account  and  shows  the  amount  of  the  inventory  at 
the  end  of  the  last  fiscal  period  for  which  reports  were  prepared. 

Illustration  of  the  inventory  account  and  the  adjustments.  The 
nature  of  the  entries  necessary  to  make  the  adjustments  required  to 
show  the  inventory  changes  may  be  made  clearer  to  the  student  by 
showing  how  they  affect  the  accounts  involved.  Wayne  Williams' 
inventory  for  December  31,  1918,  is  $2,500,  and  that  is  the  debit 
balance  which  would  appear  in  the  account  at  the  time  the  preliminary 
trial  balance  is  taken  on  December  31,  1919.  The  account  before 
any  adjusting  entry  is  made  appears  as  follows: 

MERCHANDISE  INVENTORY 


1919 

Tan.  i 

2,  COO 

oo 

It  was  seen  that  on  the  statement  of  profit  and  loss  the  inventory 
at  the  beginning  of  the  period  is  added  to  the  amount  of  the  purchases 
for  the  period  as  part  of  the  process  of  obtaining  the  cost  of  goods  sold. 
In  order  to  bring  the  ledger  into  accord  with  this  statement,  the 
amount  of  this  old  inventory  will  be  added  to  the  purchases  as  shown 
in  the  purchases  account.  This  is  accomplished  by  debiting  the 
purchases  account  with  the  amount  of  the  old  inventory,  and  crediting 
the  inventory  account  with  that  amount.  This  has  the  effect  of 
subtracting  from  the  inventory  account  the  amount  of  the  old  balance, 
and  of  adding  it  to  the  amount  of  purchases,  thus  showing  the  total 
amount  of  goods  which  were  available  during  the  period  and  which 
could  possibly  have  been  sold.  The  two  accounts  affected  by  this 
entry  will  appear  as  follows: 

MERCHANDISE  INVENTORY 


1919 

Tan.  i 

2  coo 

oo 

1919 
Dec  31 

Purchases 

2,  COO 

oo 

PURCHASES 


1919 

Dec.  31 

Balance 

18,00000 

3i 

Inventory 

2,50000 

IO4 


PRINCIPLES  OF  ACCOUNTING 


By  reference  to  the  inventory  account  it  will  be  seen  that  the 
debits  and  credits  in  that  account  are  now  equal.  When  this  is  true 
of  any  account,  the  account  is  said  to  be  in  balance.  This  may  be 
indicated  by  totaling  the  two  sides,  writing  both  totals  on  the  line 
where  the  total  of  the  longer  side  falls,  and  drawing  double  lines 
beneath  the  two  totals.  These  double  lines  signify  that  there  is 
equality  between  the  two  sides  to  that  point,  and  that  all  above  the 
double  lines  may  be  ignored  in  the  future.  In  this  account  there  is 
only  one  item  on  each  side,  and  the  fact  that  the  account  is  in  balance 
may  be  indicated  as  follows: 

INVENTORY 


1919 

Jan.  i 

2>5°° 

oo 

1919 
Dec.  31 

Purchases 

2,500 

oo 

In  the  statement  of  profit  and  loss  it  was  seen  that  the  amount 
of  the  inventory  on  hand  at  the  end  of  the  period  was  deducted  from 
the  sum  of  the  inventory  at  the  beginning  and  the  purchases  for  the 
period,  in  order  to  arrive  at  the  cost  of  the  goods  sold.  This  deduc- 
tion can  be  shown  in  the  ledger  and  the  inventory  account  be  made  to 
show  the  amount  of  the  newly  ascertained  inventory  by  an  entry 
debiting  the  inventory  account  and  crediting  purchases  account. 
Such  an  entry,  as  will  appear  from  the  illustration,  has  the  double 
effect  of  deducting  the  amount  from  purchases  and  of  setting  up  in  the 
ledger  the  amount  of  the  inventory  now  on  hand.  The  following 
illustration  shows  how  these  accounts  will  then  appear: 

INVENTORY 


1919 

Jan.     i 
Dec.  31 

2,500 

oo 

1919 

Dec.  31 

Purchases 

2,500 

oo 

3,5°° 

oo 

PURCHASES 


1919 

1919 

Dec.  31 

Balance 

18,000 

oo 

Dec.  31 

Inventory 

3,5°° 

oo 

3t 

Inventory 

2,500 

oo 

THE  ADJUSTING  ENTRIES 


105 


Office  furniture  and  delivery  equipment.  The  inventory  account 
having  been  adjusted  so  as  to  be  in  harmony  with  the  balance  sheet, 
it  is  now  necessary  to  adjust  the  accounts  with  the  fixed  assets  so  as 
to  show  the  estimated  depreciation  as  shown  by  the  balance  sheet. 
If  it  is  estimated  that  the  office  furniture  has  depreciated  in-  value 
to  the  amount  of  $50,  this  amount  may  be  shown  as  a  credit  to  a 
reserve  for  depreciation  account,  and  as  a  debit  to  some  expense 
account.  Since  the  office  furniture  is  used  in  the  administration 
of  the  business,  the  depreciation  arising  therefrom  may  be  considered 
as  a  charge  or  debit  to  administrative  expense.  Since  the  delivery 
equipment  is  used  in  connection  with  the  delivery  of  merchandise, 
the  depreciation  on  it  may  be  treated  as  a  delivery  expense.  Accord- 
ingly the  estimated  depreciation  of  $160  on  delivery  equipment  will 
be  debited  to  the  delivery  expense  account. 

After  these  entries  have  been  made,  the  two  reserve  accounts  and 
the  administrative  expense  and  delivery  expense  accounts  will  appear 
as  follows : 

ADMINISTRATIVE  EXPENSE 


1919 

Dec.  31 
3i 

Balance 
Depreciation   on 
equipment 

3,3i6 
50 

00 
00 

DELIVERY  EXPENSE 


1919 

Dec.  31 

Balance 
Depreciation    on 

59° 

oo 

delivery  equip- 
ment 

160 

oo 

1919 

Dec.  31 

CO 

oo 

RESERVE  FOR  DEPRECIATION  OF  DELIVERY  EQUIPMENT 


1919 

Dec.  31 

160 

oo 

Io6  PRINCIPLES  OF  ACCOUNTING 

Methods  of  showing  expenses  in  accounts.  In  the  accounts  shown 
in  this  chapter  and  the  following  chapter  the  expenses  of  the  year  are 
shown  in  total.  The  student  will  understand  that  numerous  debits 
may  be  made  to  the  accounts  during  the  year.  In  the  illustrations 
the  total  only  is  shown  for  the  sake  of  simplicity. 

QUESTIONS  FOR  CLASS  DISCUSSION 
r' 

1.  Explain  and  illustrate  the  meaning  and  purpose  of  adjusting  entries. 

2.  H.  B.  Jones  purchases  office  furniture  on  January  i  for  $400.00  which  he 
estimates  will  be  of  service  for  ten  years.    What  entries  will  be  necessary 
in  Jones's  ledger  at  the  end  of  the  fiscal  year  December  31,  1918,  in 
order  to  show  the  depreciation  on  office  furniture  ? 

3.  On  December  31  A.  B.  King  has  500  units  of  merchandise  on  hand  which 
cost  80  cents  a  unit,  but  which  he  can  now  purchase  at  70  cents  a  unit. 
The  retail  selling  price  of  the  articles  is  90  cents.    At  what  price  should 
this  merchandise  appear  on  the  balance  sheet  of  King  ? 

4.  On  the  statement  of  profit  and  loss  of  H.  M.  James  the  cost  of  goods 
sold  is  shown  as  follows: 

COST  OF  GOODS  SOLD 

Inventory,  January  i,  1919    .     $  4,000.00 
Purchases 12,000.00 


Less:  $16,000.00 

Inventory,  December  31,  1919    5,000.00 

Net  cost  of  goods  sold     .       .       .  $11,000.00 

What  entries  would  be  required  to  show  the  cost  of  goods  sold  in  the 
ledger  of  H.  M.  James  ? 

5.  Explain  and  illustrate  the  use  of  the  inventory  account. 

6.  On  January  i  A.  M.  Long  purchases  delivery  equipment  which  costs 
$1,600.00.    He  estimates  that  it  will  be  of  service  ten  years  and  will  have 
a  scrap  value  of  $200.000.    What  entries  would  be  made  in  eonnection 
with  delivery  equipment  on  December  31  ? 

7.  The  store  building  of  the  Chicago  Mercantile  Company  has  depre- 
ciated $500.00  during  the  year.     What  entries  should  be  made  to  record 
this  depreciation? 

8.  On  the  statement  of  profit  and  loss  of  the  Brown  Retail  Store  there 
appears  the  following  item: 

Depreciation $460.00 

What  does  this  probably  include?    What  criticism  would  you  offer 
of  this  method  of  showing  depreciation  ? 


THE  ADJUSTING  ENTRIES 


107 


9.  At  the  end  of  the  fiscal  period  you  are  instructed  to  make  the  adjusting 
entries  for  the  records  of  the  X.Y.  Manufacturing  Company.  Explain 
how  you  would  proceed  and  what  information  you  would  desire  before 
making  these  entries. 

10.  Explain  the  difference  between  the  adjusting  entries  required  by  a 
manufacturing  firm  and  by  a  mercantile  firm. 

REFERENCES  FOR  FURTHER  STUDY 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xvi. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  x. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  pp.  154-56. 

LABORATORY  EXERCISE  NO.  19 
The  following  is  the  trial  balance  of  H.  A.  Smith: 

H.  A.  SMITH 
TRIAL  BALANCE,  DECEMBER  31,  1919 


Cash  

2,000 
300 
3,7oo 
3,100 
500 
2,000 
1.500 

250 

29,000 
1,000 
3,000 
800 
3,400 

00 

oo 
oo 
oo 
oo 
oo 
oo 

00 

oo 
oo 
oo 
oo 

CO 

800 

2,900 

6,850 

40,000 

00 

00 

oo 
oo 

Notes  Receivable  *  

Accounts  Receivable  

Merchandise  Inventory,  January  r,  1919  

Office  Furniture  

Buildings  

Land  

Notes  Payable  

Accounts  Payable  

H.  A.  Smith,  Proprietor  

H.  A.  Smith,  Personal  

Sales  

Purchases  

Buying  Expenses  

Selling  Expenses  

Delivery  Expenses  

Administrative  Expenses  

So,S5o 

oo 

50,550 

00 

V 

Assuming  that  Smith's  inventory  on  December  31  is  $4,500.00  and  that 
the  depreciation  on  office  furniture  is  10  per  cent  and  on  buildings  5  per  cent, 
make  a  balance  sheet  and  statement  of  profit  and  loss  for  Smith. 

LABORATORY  EXERCISE  NO.  20 

On  loose  leaf  ledger  paper  open  accounts  to  give  effect  to  trial  balance 
of  Smith.    Allow  five  lines  for  each  account.    Make  the  entries  necessary 
to  adjust  the  ledger  accounts  of  Smith  so  they  will  agree  with  his  balance 
sheet  and  statement  of  profit  and  loss. 
Preserve  this  exercise  for  future  use. 


io8  PRINCIPLES  OF  ACCOUNTING 

LABORATORY  EXERCISE  NO.  21 
Make  the  entries  necessary  to  adjust  the  ledger  of  J.  B.  Moseley  as 

prepared  in  Exercise  No.  13,  so  as  to  give  effect  to  the  adjustments  stated 

in  Exercise  No.  18. 

Preserve  this  exercise  for  future  use. 

LABORATORY  EXERCISE  NO.  22 
Make  the  entries  necessary  to  adjust  the  ledger  of  H.  T.  Jones  as  given 

in  Exercise  No.  14.    The  data  for  the  adjustments  are  given  in  Exercise 

No.  15. 

Preserve  this  exercise  for  future  use. 


CHAPTER  X 

THE  CLOSING  ENTRIES 

Purpose  of  the  closing  entries.  After  the  adjusting  entries  are 
made  at  the  end  of  the  fiscal  period,  the  accounts,  with  the  exception 
of  the  proprietorship  accounts,  furnish  the  information  which  should 
appear  in  the  accounting  reports.  The  next  steps  are:  (i)  to  make 
the  ledger  show  a  summary  of  income  and  expense  similar  to  that 
which  will  appear  in  the  profit  and  loss  statement;  and  (2)  to  bring 
the  balances  of  the  proprietorship  accounts  up  to  date,  so  that  these 
balances  will  show  the  amount  of  proprietorship  which  should  appear 
in  the  balance  sheet.  In  order  that  these  two  things  may  be  accom- 
plished, certain  accounts  must  be  "closed."  The  entries  necessary 
to  affect  this  closing  are  known  as  "closing  entries,"  and  it  is  the 
purpose  of  the  present  chapter  to  explain  how  these  entries  are 
made. 

Gross  profit  on  sales.  In  making  the  ledger  summary  it  is  desirable 
to  follow  the  order  indicated  by  the  statement  of  profit  and  loss. 
By  reference  to  the  statement  of  profit  and  loss  it  will  be  seen  that 
the  cost  of  goods  sold  is  subtracted  from  the  amount  of  the  sales,  to 
arrrive  at  the  gross  profit  from  sales.  It  appears  there  also  that  the 
cost  of  goods  sold  is  obtained  by  adding  to  purchases  the  inventory 
at  the  beginning  and  subtracting  from  the  sum  thus  obtained  the 
inventory  at  the  end  of  the  period.  In  the  adjusting  entries  discussed 
in  the  preceding  chapter,  the  purchases  account  was  so  adjusted,  by 
adding  the  initial  inventory  and  subtracting  the  final  inventory, 
as  to  make  the  balance  of  that  account  show  the  cost  of  the  goods 
sold  for  the  period.  The  next  step,  then,  is  to  show  the  cost  of  goods 
sold  as  shown  by  the  purchases  account  as  a  subtraction  from  sales, 
and  this  is  accomplished  by  transferring  the  debit  balance  of  the 
purchases  account  to  the  sales  account.  This  transfer  is  effected  by 
debiting  the  sales  account  and  crediting  the  purchases  account  with 
the  balance  of  the  purchases  account.  When  this  entry  has  been 
made,  the  purchases  and  sales  accounts  will  appear  on  page  no. 

109 


no 


PRINCIPLES  OF  ACCOUNTING 
PURCHASES 


1919 

1919 

Dec.  31 

Balance 

18,000 

oo 

Dec.  31 

Inventory 

3>5°° 

00 

3i 

Inventory 

2,500 

00 

3i 

Cost    of     goods 

sold 

17,000 

00 

20,500 

oo 

20.500 

oo 

SALES 


1919 

1919 

Dec.  31 

Cost  of  goods 

Dec.  31 

Balance 

24,000 

00 

sold 

17,000 

00 

31 

Gross  profit  on 

sales 

7,000 

oo 

24,000 

oo 

24,000 

00 

It  will  be  seen  that  crediting  the  purchases  account  for  the  amount 
of  the  cost  of  goods  sold  makes  the  debits  and  credits  in  that  account 
equal  in  amount;  in  other  words,  it  brings  the  account  to  a  balance. 
This  would  be  indicated  by  totaling  the  two  sides  of  the  account, 
writing  the  totals  opposite  one  another,  and  drawing  double  lines 
under  each  of  the  totals,  which  indicates  that  the  debits  and  credits 
in  the  account  up  to  this  point  are  equal.  The  purchases  account 
is  now  said  to  be  "closed"  for  the  period,  and  no  further  entries  will 
appear  in  it  until  the  transactions  of  the  next  period  begin  to  be 
recorded. 

Profit  and  loss  account.  When  the  cost  of  goods  sold  has  been 
transferred  to  the  sales  account,  the  balance  of  this  account  shows  the 
gross  profit  on  sales.  By  reference  to  the  statement  of  profit  and  loss 
it  will  be  seen  that  the  next  step  in  making  a  summary  of  the  oper- 
ations of  the  period  is  to  subtract  from  the  gross  profit  on  sales  the 
operating  expenses,  so  as  to  determine  the  net  operating  profit.  In 
order  to  show  the  net  operating  profit  in  the  ledger  it  is  customary 
to  open  an  account  termed  the  profit  and  loss  account,  to  which  the 
operating  expenses  are  debited  and  the  operating  income  credited. 

The  purpose  of  the  profit  and  loss  account  is  to  offset  the  operating 
expenses  of  the  period  against  the  operating  income  with  the  resulting 


THE  CLOSING  ENTRIES 


ill 


balance,  which  shows  the  net  operating  profit.  This  account  is 
sometimes  termed  a  summary  account  because  it  is  used  to  summarize 
the  operations  of  the  period.  It  is  opened  only  at  the  end  of  the  fiscal 
period  and  is  closed  as  soon  as  the  ledger  summary  is  made.  Entries 
during  the  fiscal  period  should  not  be  entered  in  this  account. 

The  debits  and  credits  to  be  made  to  the  profit  and  loss  account 
are  as  follows: 

PROFIT  AND  LOSS 


Dcbti: 

With  the  amount  of  the  balance  of  each 
account  which  shows  an  item  of  oper- 
ating expense. 


Credit: 

"\Yith  the  amount  of  the  balance  of 
each  account  which  shows  an  item 
of  operating  income. 


As  indicated  in  the  discussion  of  the  statement  of  profit  and  loss, 
there  may  be  non-operating  expenses  and  non-operating  income,  and 
frequently  both  of  these  are  shown  in  the  profit  and  loss  account. 
However,  such  items  should  be  shown  in  a  separate  section  of  the 
profit  and  loss  account,  just  as  they  are  shown  in  a  separate  section  of 
the  statement  of  profit  and  loss.  The  recording  and  reporting  of  these 
items  will  be  considered  later.  For  the  present,  the  profit  and  loss 
account  may  be  considered  as  a  summary  of  operating  income  and 
expense  only. 

The  balance  of  the  profit  and  loss  account  may  appear  on  either 
side,  depending  on  whether  the  total  expense  balances  or  the  total 
income  balances  are  in  excess.  A  credit  balance  in  this  account  shows 
the  amount  of  the  net  operating  profit  for  the  period  and  is  transferred 
to  the  credit  side  of  the  proprietor's  account.  A  debit  balance  in  this 
account  shows  a  net  loss  for  the  period  and  is  transferred  to  the 
debit  side  of  the  proprietor's  account. 

Net  operating  profit.  In  the  previous  discussion  it  appeared  that 
the  gross  profit  on  sales  as  shown  by  the  balance  of  the  sales  account 
is  $7,000.  This  credit  balance  of  the  sales  account  will  next  be  trans- 
ferred to  the  profit  and  loss  account  by  debiting  sales  for  that  amount 
and  crediting  Profit  and  Loss.  After  this  is  done,  the  balances  of  all 
the  operating  expense  accounts  will  be  transferred  to  the  debit  of  the 
profit  and  loss  account  by  crediting  each  expense  account  with  the 
amount  of  its  debit  balance  and  debiting  Profit  and  Loss  for  that 


112 


PRINCIPLES  OF  ACCOUNTING 


amount.  When  this  has  been  done,  the  accounts  with  purchases 
and  sales  and  with  each  item  of  operating  expense  will  be  balanced 
and  may  be  ruled  up  as  "closed."  The  profit  and  loss  account  will 
show  a  credit  balance  of  $1,000,  agreeing  with  the  net  income  shown 
by  the  statement  of  profit  and  loss.  This  credit  balance  will  then 
be  transferred  from  the  profit  and  loss  account  to  the  credit  of  the 
proprietor's  account  by  debiting  Profit  and  Loss  for  the  amount 
and  crediting  the  proprietor's  account. 

When  all  these  closing  entries  have  been  made,  the  accounts 
affected  by  them,  omitting  the  details  of  the  entries  made  during  the 
period  just  past,  will  be  as  follows: 

PURCHASES 


1919 

Dec.  31 
31 

Balance 
Inventory 

18,000 
2,500 

00 

•oo 

1919 

Dec.  31 
3i 

Inventory 
Cost  of  goods  sold 

3,500 
17,000 

oo 

00 

20,500 

oo 

20,500 

00 

SALES 


1919 

] 

1919 

Dec.  31 

Cost  of  goods 

Dec.  31 

Balance 

24,000 

00 

sold 

17,000 

oo 

31 

Gross  profit  on 

sales 

7,000 

oo 

24,000 

oo 

24,000 

oo 

BUYING  EXPENSES 


1919 

Dec.  31 

Balance 

444 

oo 

1919 
Dec.  31 

Profit  and  loss 

444 

oo 

SELLING  EXPENSES 


1919 

Dec.  31 

Balance 

1,440 

oo 

1919 
Dec.  31 

Profit  and  loss 

1,440 

00 

THE  CLOSING  ENTRIES 
DELIVERY  EXPENSES 


i 

1919 

1919 

Dec.  31 

Balance 

59° 

oo 

Dec.  31 

Profit  and  loss 

75° 

oo 

3i 

Depreciation  on 

delivery  equip- 

ment 

1  60 

oo 

75° 

oo 

75° 

oo 

ADMINISTRATIVE  EXPENSES 


1919 

1919 

Dec.  31 

Balance 

3,316 

oo 

Dec.  3  1 

Profit  and  loss 

3,366 

00 

31 

Depreciation  on 

office  furniture 

50 

oo 

3,366 

oo 

3.366 

oo 

PROFIT  AND  LOSS 


1919 

1919 

Dec.  3  1 

Buying  expense 

444 

oo 

Dec.  31 

Gross    profit    on 

3i 

Selling  expense 

1,440 

oo 

sales 

7,000 

oo 

3i 

Delivery  expense 

750 

oo 

3i 

Administrative 

expense 

3»366 

oo 

9 

3i 

Net  profit 

1,000 

oo 

7,000 

oo 

7,000 

oo 

W.  A.  WILLIAMS,  PROPRIETOR 


1919 

Dec.  31 

Net  worth 

7,630 

oo 

1919 
Jan.    i 
Dec.  31 

Dec.  31 

6,630 

I,  COO 

00 

oo 

Profit  and  loss 

7,630 

oo 

7,630 

oo 

7,63ojoo 

The  ledger  after  closing.  After  the  closing  entries  have  been  made, 
all  of  the  expense  and  income  accounts  have  been  brought  to  a  bal- 
ance and  "closed"  or  ruled  off.  They  are  now  ready  for  the  first 


114  PRINCIPLES  OF  ACCOUNTING 

entries  to  be  made  in  them  to  show  the  income  and  expense  of  the 
next  period.  The  profit  and  loss  account  has  been  made  to  show  a 
summary  of  income  and  expense  in  such  a  way  as  to  give  in  the  ledger 
the  information  used  in  preparing  the  statement  of  profit  and  loss 
and  the  results  shown  by  the  account  are  in  harmony  with  the  results 
presented  in  the  statement.  The  accounts  which  still  remain  "open," 
that  is,  have  balances,  are  the  asset,  liability,  and  proprietorship 
accounts.  If  a  trial  balance  is  taken  at  this  time,  the  items  appear- 
ing thereon  will  correspond  with  the  items  shown  on  the  balance 
sheet. 

Balancing  and  closing  the  accounts.  The  method  of  ruling  up  and 
closing  an  account  when  it  is  in  balance  has  been  explained.  When 
an  account  is  in  balance  and  is  closed,  nothing  appears  below  the 
double  lines,  and  the  accountant  understands  from  a  glance  at  the 
account  that  there  is  no  balance  to  be  considered. 

Occasionally,  however,  it  is  desirable  to  rule  up  an  account  in  such 
a  way  as  to  show  the  difference  between  the  two  sides.  This  is  done 
by  writing  the  balance,  or  the  excess  of  one  side  over  the  other,  on  the 
side  having  the  smaller  amount,  drawing  the  single  lines  under  the 
two  sides  and  totaling  the  two  sides  which  must  now  be  equal,  since 
the  difference  has  been  added  to  the  smaller  side.  The  double  lines 
are  then  drawn  beneath  the  totals,  indicating  equality  to  that  point, 
and  trie  balance  is  entered  below  these  double  lines  and  on  the  side 
which  is  in  excess  by  that  amount.  The  equality  between  debits  and 
credits  is  not  disturbed  by  this  process,  since  the  same  amount  is 
added  to  each  side  of  the  account.  When  an  account  is  ruled  up  in 
this  manner,  the  accountant  can  see  at  a  glance  what  the  balance  is. 
It  is  not  customary  in  the  case  of  most  of  the  accounts  to  balance 
them  and  bring  down  the  balance.  The  usual  procedure  in  getting 
the  balance  is,  as  previously  explained,  to  enter  the  total  under  each 
side  in  small  pencil  figures,  and  note  the  balance  to  that  point,  also  in 
pencil,  on  the  side  which  is  in  excess  of  the  other.  The  cash  account 
is  usually  the  only  one  that  is  regularly  balanced  in  the  formal  fashion 
described  above.  Assuming  that  an  account  with  cash  was  carried 
in  Wayne  Williams'  ledger,  the  totals  being  entered  monthly,  it  might 
appear  at  the  end  of  the  year,  after  a  balance  had  been  taken,  as 
follows: 


THE  CLOSING  ENTRIES 


CASH 


1920 
Jan.     i 
Jan.  31 
Feb.  29 
Mar.  31 
April  30 
May  31 
June  30 
July  31 
Aug.  31 
Sept.  30 
Oct.  31 
Nov.  30 
Dec.  31 

1921 

Balance 

i,  800 
4,000 
3,200 
3,400 
4,000 
3,800 
3,100 

2,000 

3.000 

3,100 

3,700 

4,100 
4,000 

00 

oo 
oo 
oo 
oo 
oo 
oo 
oo 
oo 
oo 

00 

oo 
oo 

1920 
Jan.   31 
Feb.  29 
Mar.  31 
April  30 
May  31 
June  30 
July  31 
Aug.  31 
Sept.  30 
Oct.  31 
Nov.  30 
Dec.  31 
Dec.  31 

4,200 
2,700 
3,800 
4,000 
2,500 
3,3oo 
3,000 
2,500 
3,500 
3,500 
4,100 
5,500 
1,500 

oo 

00 

oo 

oo 
oo 
oo 
oo 

00 
00 
00 

oo 
oo 
oo 

Balance 

Balance 

44,100  oo 

44,100 

oo 

1,500  oo 

_  The  ruling  of  current  accounts  with  persons  and  of  note  accounts. 
It  was  pointed  out  in  the  foregoing  discussion  that  the  cash  account  is 
usually  the  only  one  of  the  property  accounts  that  is  balanced  under 
ordinary  circumstances.  The  others  are  usually  left  open,  since  they 
furnish  thus  a  better  means  of  tracing  through  the  account  the  history 
of  the  particular  item  involved. 

Accounts  with  persons,  particularly  the  accounts  with  customers, 
making  up  the  item  of  accounts  receivable,  and  those  with  creditors, 
composing  the  accounts  payable  group,  offer  a  peculiar  problem,  as 
do  also  notes  receivable  and  notes  payable.  Such  accounts  have  so 
many  items  that  they  cannot  be  allowed  to  run  on  indefinitely,  taking 
the  complete  total  of  the  debits  and  credits  up  to  date.  Such  a  pro- 
cedure would  compel  the  bookkeeper,  whenever  he  wished  to  ascer- 
tain the  present  balance  of  the  account,  to  add  all  the  debits  and  all 
the  credits  which  had  been  made  to  that  account.  But  in  order  to 
be  able  to  obtain  a  clear  analysis  of  the  balance  in  such  an  account  at  a 
given  time,  it  is  not  desirable  to  balance  it  formally,  since  it  is  a  current 
account,  and  it  should  be  kept  so  that  its  current  balance  at  a  given 
time  can  be  readily  analyzed.  It  is  usual  for  a  customer,  when  he 
does  make  a  payment,  to  pay  an  amount  which  covers  certain  definite 
items  with  which  his  account  has  been  previously  debited,  rather  than 
simply  to  make  "on  account"  a  payment  of  an  amount  which  does 
not  correspond  with  any  of  the  debits  to  his  account.  It  is  desirable, 


n6 


PRINCIPLES  OF  ACCOUNTING 


therefore,  that  in  keeping  such  an  account,  whether  from  the  stand- 
point of  the  buyer  or  that  of  the  seller,  -some  attempt  should  be  made 
to  identify  as  nearly  as  possible  the  debit  items  with  the  particular 
credits,  which  record  the  discharge  of  the  indebtedness  shown  by  these 
debits.  This  may  be  accomplished  by  lettering  the  items,  which  can  be 
identified  as  thus  offsetting  one  another.  It  will  also  usually  be  found 
true  that  all  the  debits  up  to  a  certain  point  are  canceled  by  the 
credits  up  to  a  certain  point,  so  that  the  balance  of  the  account, 
whether  debit  or  credit,  is  to  be  arrived  at  by  a  consideration  of  items 
below  a  certain  line  on  each  side  of  the  account.  This  is  true  of 
accounts  receivable,  accounts  payable,  notes  receivable,  and  notes 
payable. 

The  use  of  the  devices  discussed  may  be  illustrated  by  an  account 
with  an  individual  customer. 

H.  E.  WHITE 


1920 
Jan.     i 
Jan.     9 

Jan.  i 6 
Jan.  22 
Jan.  29 

Feb.  i 
Feb.  25 

Mar.  5 
Mar.  27 


Balance 


a     3500 
a     1500 


b  12  50 
b  17)50 
b  1500 


IO  OO 

iS'oo 


2500 
15  oo 


IQ2O 

Jan.  16 
Feb.  2 
Mar.  3 


a    5000 
b    45 
c    2800 


This  should  be  enough  to  indicate  the  method  employed.  The 
number  of  debit  items  canceled  by  one  credit  item  will  vary  in  different 
kinds  of  businesses  according  to  the  practice  of  the  trade  and  accord- 
ing to  the  habit  of  the  customer.  In  a  wholesale  business  it  is  usual 
to  receive  a  separate  check  from  the  customer  to  cover  each  invoice 
separately.  In  accounts  with  notes,  there  will  usually  be  the  same 
number  of  debits  as  there  are  offsetting  credit  items,  since  a  note  is 
usually  canceled  by  a  single  payment.  A  practice  sometimes  fol- 
lowed in  keeping  note  accounts  is  to  enter  each  item,  indicating  the 
cancellation  of  a  note  on  the  line  opposite  the  item  which  it  cancels, 
regardless  of  chronological  order.  This  is  hardly  necessary,  however, 
if  the  device  just  illustrated  is  employed. 


THE  CLOSING  ENTRIES  117 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  Explain  and  illustrate  the  meaning  and  purpose  of  "closing  entries." 

2.  J.  A.  Bowen  has  made  sales  to  the  amount  of  $12,000.00  during  the 
month.    The  cost  of  the  goods  sold  is  $9,000.00.     Explain  how  the 
gross  profit  on  sales  would  be  shown  in  the  ledger. 

3.  The  expenses  of  Bowen  for  the  month  are  as  follows:   buying  expenses, 
$200.00;  selling  expenses,  $600.00;  delivery  expenses,  $300.00;  admin- 
istrative expenses,  $900.00.    What  would  be  the  net  profit  of  Bowen 
and  how  would  this  be  shown  on  his  ledger  ? 

4.  Explain  the  purpose  of  the  profit  and  loss  account. 

5.  What  is  the  relation  between  the  profit  and  loss  account  and  the  state- 
ment of  profit  and  loss  ? 

6.  What  entries  would  be  necessary  to  close  the  profit  and  loss  account  of 
J.  A.  Bowen  ? 

7.  The  total  of  the  debits  to  the  sales  account  is  $8,000.00  and  the  total  of 
the  credits  to  this  account  are  the  same.    How  is  the  equality  of  debits 
and  credits  shown  ? 

8.  The  total  of  the  debits  to  the  cash  account  is  $6,000.00  and  the  total  of 
the  credits  is  $4,000.00.    What  is  the  cash  balance?    How  may  this 
balance  be  shown  in  the  account  ? 

9.  Explain  how  a  personal  account  may  be  ruled. 

10.  The  total  of  the  debits  to  the  cash  account  is  $12,000.00  and  th^  totals  of 
the  credits  is  $8,000.00.    The  ledger  page  on  which  the  cash  account 
appears  is  filled  and  it  is  necessary  to  transfer  this  account  to  a  new  page. 
Explain  how  this  may  be  done. 

11.  Explain  any  other  method  than  the  one  outlined  in  chapter  x  which 
might  be  used  to  close  the  ledger  at  the  end  of  the  fiscal  period. 

12.  After  the  closing  entries  have  been  made,  what  accounts  remain  open 
in  the  ledger  ? 

REFERENCES  FOR  FURTHER  STUDY 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  xiv. 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xxx. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  pp.  184-86. 

LABORATORY  EXERCISE  NO.  23 

Make  the  entries  necessary  to  close  the  ledger  of  H.  A.  Smith  as  prepared 
in  Exercise  No.  20.    Rule  the  accounts  that  balance. 

LABORATORY  EXERCISE  NO.  24 

Make  the  entries  necessary  to  close  the  ledger  of  J.  B.  Moseley  as 
prepared  in  Exercise  No.  21.    Rule  the  accounts  that  balance. 

LABORATORY  EXERCISE  NO.  25 

Make  the  entries  necessary  to  close  the  ledger  of  H.  T.  Jones  as  prepared 
in  Exercise  No.  22.    Rule  the  accounts  that  balance. 


CHAPTER  XI 
THE  SOURCE  OF  THE  LEDGER  ENTRIES 

Need  of  a  record  other  than  the  ledger.  In  the  foregoing  chapters 
it  has  been  seen  that  the  function  of  the  accountant  is  primarily  that 
of  furnishing  the  business  manager  with  such  information  about  his 
business  as  will  be  of  the  greatest  aid  to  him  in  planning  further 
business  operations.  It  has  been  explained  that  this  information  is 
presented  in  the  form  of  reports,  and  that  it  should  be  classified  and 
presented  in  such  fashion  as  to  make  it  not  only  intelligible  but  also 
applicable  to  the  solution  of  the  particular  problems  of  the  business 
manager  for  whose  use  it  is  prepared.  Since  there  are  typically 
several  different  parties  interested  in  the  business,  each  interested 
from  a  somewhat  different  point  of  view  from  the  others,  there  will 
usually  be  need  for  several  types  of  reports,  each  of  which  will  present 
certain  data  about  the  business,  classified  on  a  basis  which  will  make 
it  most  useful  to  the  individual  or  group  for  whom  the  report  is  drawn 
up.  Thus  the  vice-president  in  charge  of  finance  might  desire  infor- 
mation concerning  past  sales,  as  well  as  the  estimates  of  future  sales, 
classified  to  show  what  amount  of  the  sales  were  made  for  cash  and 
what  amount  on  credit,  and  might  also  wish  to  have  the  credit  sales 
classified  according  to  the^  terms  of  credit  allowed.  The  merchandise 
manager,  with  the  departmental  buyers,  might  be  interested  in  the 
classification  of  sales  on  the  basis  of  the  commodities  sold,  and  the 
amount  of  each  commodity  sold  during  each  month  of  the  year,  since 
it  is  the  task  of  these  functionaries  to  see  that  the  stock  is  kept  up  to 
meet  demands,  and  at  the  same  time  to  avoid  being  caught  with  an 
excess  of  any  type  of  goods. 

The  wide  range  of  classification  required  in  the  reports  means  that 
there  must  be  an  equally  wide  range  in  the  ledger,  since  the  data  for  each 
item  in  the  reports  must  be  gathered  into  a  separate  account  in  the 
ledger.  It  has  been  previously  explained  how  each  transaction  may  be 
analyzed  with  regard  to  its  effect  upon  the  ledger  accounts,  and  how 
this  analysis  is  reflected  in  the  accounts  themselves. 

1x8 


THE  SOURCE  OF  THE  LEDGER  ENTRIES  IIQ 

Accounting  experience  has  shown  clearly,  however,  that  it  is  not 
desirable  to  enter  this  information  into  the  account  directly,  at  the 
time  that  each  transaction  takes  place.  It  is  better  to  maintain  some 
earlier  form  of  record,  in  which  may  be  entered  the  analysis  of  each 
transaction,  showing  each  account  to  be  debited  and  each  one  to  be 
credited,  together  with  the  amount  of  each  debit  or  credit  and  any 
other  explanation  which  may  seem  desirable  with  regard  to  the  nature 
of  the  transaction. 

One  reason  why  this  method  of  procedure  has  been  found  desirable 
is  that  it  would  plainly  be  inconvenient  and  a  waste  of  tune  to  turn 
to  each  of  the  ledger  accounts  affected  by  each  transaction  and  make 
the  entries  there  at  the  time  when  the  transaction  occurs.  It  is 
better  to  enter  the  analysis  of  each  transaction  in  its  chronological 
order  on  a  special  record  kept  for  that  purpose,  and  to  transfer  these 
items  to  the  appropriate  ledger  accounts  at  a  time  when  this  transfer 
may  be  made  systematically  and  efficiently. 

Another  reason  is  that  the  account  is  employed  merely  as  a  means 
of  classifying  and  summarizing  information  concerning  certain  items 
appearing  on  the  reports,  and  is  not  designed  to  furnish  any  history 
or  explanation  of  the  particular  transactions.  It  is  desirable  to  keep 
a  record  of  certain  details  with  regard  to  each  transaction,  and  this 
can  be  done  best  by  the  use  of  an  additional  record,  such  as  is  here 
under  consideration.  Also,  the  transactions  as  a  whole  are  by  this 
means  entered  in  chronological  order,  thus  supplying  a  continuous 
record  of  the  transactions  of  the  business  over  any  given  period  of 
time. 

Again,  the  debits  and  credits  resulting  from  any  transaction  are 
entered  in  different  accounts,  and  if  an  error  should  be  made  in  enter- 
ing one  of  them,  the  error  would  be  very  difficult  to  trace  without  the 
aid  of  an  original  record  of  the  transaction  as  a  whole.  Thus  if  Wayne 
Williams  sells  Milton  Jones  goods  to  the  amount  of  $100,  Jones's 
account  should  be  debited  with  that  amount,  and  sales  credited. 
If  through  an  error  sales  is  credited  with  $10  instead  of  $100,  and  the 
trial  balance  at  the  end  of  the  period  is  found  to  be  out  of  balance 
as  a  consequence,  it  will  be  much  more  difficult  to  locate  the  error  if 
there  is  no  book  of  original  entry  showing  a  complete  record  of  the 
transaction  with  its  debits  and  credits,  which  may  be  compared  with 
the  debits  and  credits  in  the  ledger. 


120  PRINCIPLES  OF  ACCOUNTING 

The  books  of  original  entry  may  also  be  used  as  a  means  of  pro- 
viding analyses  of  some  of  the  more  important  classes  of  transactions, 
such  analyses  being  more  difficult  to  obtain  in  any  other  way.  Such 
are  the  analyses  of  sales,  purchases,  cash  receipts,  and  cash  disburse- 
ments. The  advantages  which  may  be  obtained  in  -this  way  will  be 
explained  later. 

The  main  reasons  why  it  is  desirable  to  employ  so-called  books  of 
original  entry  to  show  the  first  analysis  of  the  transactions,  and  as  a 
medium  for  transferring  the  desired  information  into  the  accounts, 
may  be  summarized  as  follows:  (i)  The  inconvenience  and  ineffi- 
ciency of  making  the  entries  direct  to  the  ledger.  (2)  The  possibility 
of  showing  more  detail  regarding  transactions  when  books  of  original 
entry  are  used.  (3)  Each  transaction  may  be  entered  as  a  whole, 
and  in  its  chronological  order.  This  may  be  useful  for  purposes  of 
reference.  (4)  It  is  easier  to  discover  errors  when  the  ledger  items 
can  be  checked  back  to  the  books  of  original  entry.  (5)  Books  of 
original  entry  may  be  used  to  show  valuable  analysis  which  would  be 
harder  to  obtain  by  direct  entries  to  the  ledger  accounts. 

The  nature  of  books  of  original  entry.  Books  of  original  entry 
may  be  of  various  types  as  regards  their  form,  although  all  are  alike 
in  the  fact  that  they  are  designed  to  show  the  analysis  of  the  debits 
and  credits  arising  out  of  each  transaction  recorded.  The  form  of  such 
books,  as  will  appear  later,  depends  primarily  upon  what  accounts 
are  to  be  carried  in  the  ledger.  As  the  student  already  knows,  the 
accounts  carried  in  the  ledger  are  determined  by  the  items  of  infor- 
mation which  it  is  desired  to  have  shown  on  the  reports.  This  fact 
constitutes  a  valid  reason  for  a  consideration  of  the  nature  and  use 
of  the  reports  before  taking  up  the  matter  of  the  books  of  original 
entry.  The  number  and  the  types  of  reports  required,  and  the  items 
shown  by  them,  vary  with  the  nature  of  the  business  operations  and 
the  organization  of  the  managerial  force.  There  will  be  a  resulting 
variation  in  the  number  of  the  accounts  which  must  be  kept  to  make 
possible  these  reports,  and  in  the  number  and  types  of  books  of  original 
entry  which  will  be  used  to  provide  an  analysis  of  the  business 
transactions. 

While  the  form  of  the  books  of  original  entry  depends  primarily 
on  what  accounts  are  carried  in  the  ledger,  it  also  varies  secondarily 
according  to  the  frequency  with  which  certain  types  of  transactions 
occur.  Thus  if  a  certain  tvDe  of  transaction,  for  example,  the  receipt 


THE  SOURCE  OF  THE  LEDGER  ENTRIES  121 

from  customers  of  "trade  acceptances,"  occurs  frequently,  some 
special  provision  for  recording  such  transactions  will  be  made.  If  it 
occurs  infrequently,  such  special  provision  may  not  be  necessary. 

But  no  matter  what  forms  of  such  records  may  be  best  under  any 
given  circumstances,  the  underlying  principles  governing  their  use 
are  the  same  in  every  case.  In  the  following  chapter  some  of  the 
special  forms  of  books  of  original  entry  will  be  explained,  with  their 
uses  and  advantages,  but  the  remainder  of  the  present  chapter  will 
be  devoted  to  a  consideration  of  the  general  principles  applicable 
to  the  use  of  the  books  of  original  entry,  as  exemplified  by  a  simple 
type  of  such  a  record. 

The  journal.  It  is  possible  to  record  in  a  single  book  all  the  trans- 
actions which  occur  in  the  business.  Such  a  book,  in  which  every 
transaction  would  be  entered  in  its  chronological  order,  and  analyzed 
as  to  its  debits  and  credits,  is  known  as  the  journal.  While  it  is  pos- 
sible to  use  only  this  one  book,  modern  practice  employs  a  number  of 
special  records,  each  of  which  takes  over  some  of  the  original  functions 
of  the  journal,  leaving  comparatively  few  entries  to  be  made  in  the 
latter.  These  special  forms  of  record  are  sometimes  called  journals 
also,  such  as  sales  journal,  notes  journal,  and  the  like,  but  they  are 
generally  referred  to  as  books  or  records,  each  being  distinguished 
according  to  the  type  of  transaction  to  be  recorded  in  it.  Common 
examples  are  cash  books,  sales  books,  purchase  books,  and  notes 
records.  The  original  journal,  from  which  all  these  forms  have  been 
developed,  is  used  to  record  all  transactions  which  find  no  place  in  any 
of  the  special  records,  and  is  known  as  the  general  journal,  or,  more 
commonly,  simply  as  the  journal. 

It  is  nevertheless  probable  that  the  student  can  best  arrive  at  an 
understanding  of  the  nature  and  use  of  books  of  original  entry  by 
first  studying  the  use  of  the  general  journal,  since  the  other  forms  are 
simply  subdivisions  or  modifications  of  the  journal.  After  the  use  of 
this  form  has  been  made  clear,  the  various  modifications  should  offer 
little  difficulty.  The  form  of  the  journal  may  vary  somewhat  in 
practice,  but  the  following  may  be  taken  as  the  standard  form: 

JOURNAL 


(0                                        (*)                                             (3)                                 (4)                       (S) 

122  PRINCIPLES  OF  ACCOUNTING 

The  use  of  each  of  the  five  columns  indicated  on  the  standard 
form  of  journal  page  here  illustrated  may  be  described  as  follows: 

1.  Column  (i)  is  known  as  the  folio  column,  and  is  used  to  enter 
the  number  of  the  page  in  the  ledger  to  which  the  item  recorded  on 
that  line  is  transferred. 

2.  Column  (2)  may  be  called  the  account  column.     It  is  used  to 
enter  the  names  of  the  accounts  which  are  to  be  debited  and  credited 
for  the  transaction  which  is  being  entered.    The  account  to  be  debited 
is  written  first,  beginning  at  the  left-hand  side  of  the  column,  and  the 
account  to  be  credited  is  written  on  the  next  line  beneath,  but  slightly 
indented,  so  that  it  will  be  easy  hi  looking  down  the  journal  page  to 
distinguish  the  debits  from  the  credits. 

3.  Column  (3)  is  the  explanation  column,  in  which  may  be  written 
any  desired  explanation  with  respect  to  the  nature  of  the  transaction 
whose  debits  and  credits  are  being  entered.     Frequently  the  expla- 
nation is  not  confined  to  this  column,  but  begins  on  the  line  beneath 
the  name  of  the  account  to  be  credited,  and  extends  across  columns 
(2)  and  (3). 

4.  Column  (4)  is  the  debit  money  column.     In  this  column,  and 
opposite  the  name  of  the  account  to  be  debited,  is  written  the  amount 
of  the  debit. 

5.  Column  (5)  is  the  credit  money  column,  and  is  used  to  show,  on 
the  same  line  with  the  name  of  the  account  to  be  credited,  the  amount 
of  that  credit. 

It  is  customary  to  write  the  date  of  the  first  transaction  which  is 
entered  in  the  journal  at  the  top  of  the  page  above  the  double  ruling, 
giving  the  month,  day,  and  year.  The  date  of  each  later  transaction 
occurring  in  the  same  month  is  recorded  by  writing  the  number  of  the 
day  of  the  month  in  the  center  of  the  line  just  beneath  the  record  of 
the  last  preceding  transaction.  When  the  first  transaction  is  entered 
in  the  new  month,  both  the  month  and  day  will  be  given. 

Illustration  of  the  journal.  A  few  simple  illustrations  of  the  use 
of  the  journal  as  a  book  of  original  entry  is  probably  the  best  means 
of  aiding  the  student  to  understand  such  use.  For  purposes  of  illus- 
tration it  is  not  desirable  to  attempt  to  show  a  sufficient  range  or  num- 
ber of  transactions  to  represent  the  typical  business  operations  of  even 
a  very  small  business.  Certain  transactions  will  be  shown,  however, 


THE  SOURCE  OF  THE  LEDGER  ENTRIES  1 2 j 

chosen  to  illustrate  some  of  the  transactions  which  take  place  in  a 
small  clothing  store. 

Sept.    i.  Paul  Nelson  invests  $10,000.00  in  cash  in  retail  clothing 
business. 

2.  Purchases  stock  of  goods  from  O.  M.  Sims  for  cash, 
$5,000.00. 

3.  Pays  a  month's  rent  of  storeroom,  in  advance,  $75.00. 
Purchases  furniture  and    fittings    for    storeroom    for 
$350.00  cash. 

4.  Pays  for  advertising  in  local  daily  paper,  $65.00. 
Cash  sales,  $105.00. 

5.  Purchases  goods  from  Cluett,  Peabody  &  Co.  on  account, 
$750.00. 

Purchases  auto  delivery  wagon,  $800.00  cash. 

6.  Sells  goods  on  account  as  follows: 

Charles  Dwan,  $15.00. 

C.  O.  Seitz,  $45.00. 
Cash  sales,  $115.00. 
Pays  salaries  of  sales  fofce,  $50.00. 

8.  Purchases  typewriter  for  cash,  $85.00. 

Purchases  goods  from  Wilson  Bros.,  $500.00  on  account. 

9.  Receives  $15.00  cash  from  Charles  Dwan,  in  payment 
of  his  account. 

Cash  sales,  $125.00. 

10.  Purchases  office  supplies  (stamps,  stationery,  etc.),  for 
cash,  $50.00. 

Sells  for  cash,  $75.00;  on  account  as  follows: 
J.  S.  Hanson,  $55.00. 
L.  M.  Sedgwick,  $80.00. 
n.  Purchases  from  Adler  Bros.,  $850.00  on  account. 

12.  Receives  $25.00  from  C.  O.  Seitz  on  his  account. 

13.  Pays  Cluett,  Peabody  &  Co.,  $750.00. 

15.  Pays  salaries  as  follows:  sales  salaries,  $50.00;  book- 
keeper-stenographer, $25.00;  deliverymen,  $20.00. 
As  stated  above,  any  kind  of  transaction  that  can  occur  may  be 
entered  hi  the  journal.    Assuming  for  purposes  of  our  illustration  that 
all  of  these  transactions  are  entered  in  the  journal,  they  would  appear 
as  follows: 


124 


PRINCIPLES  OF  ACCOUNTING 
SEPTEMBER,  1919 


I 

Cash 

10,000 

oo 

Paul  Nelson,  proprietor 

10,000 

oo 

Paul  Nelson  invests  $10,000  cash 

in  the  retail  clothing  business 

2 

Purchases 

5,000 

oo 

Cash 

5,000 

oo 

Bought  of  O.  M.  Suns  stock  oi 

men's  furnishings  for  cash 

3 

Administrative  Expense 

75 

oo 

Cash 

75 

oo 

•' 

Paid  rent  of  store  for  September 

• 

3 

Store  Equipment 

35° 

00 

Cash 

35° 

00 

Purchased  store  furniture 

4 

Selling  Expense 

65 

oo 

Cash 

65 

oo 

Paid  for  September  ads.  in  Daily 

News 

4 

Cash 

i°5 

oo 

Sales 

I°5 

00 

Cash  sales  to  date 

5 

Purchases 

75° 

00 

Cluett,  Peabody  &  Co. 

75° 

00 

Purchased     goods    from     Cluett, 

Peabody  &  Co. 

5 

Delivery  Equipment 

800 

00 

Cash 

800 

oo 

Purchased  delivery  car  for  cash 

6 

Charles  Dwan 

IS 

00 

Sales 

IS 

00 

Sold  merchandise  to  Charles  Dwan 

on  account 

6 

C.  O.  Seitz 

45 

oo 

Sales 

45 

oo 

Sold  to  C.  O.  Seitz  merchandise  on 

account 

6 

Cash 

"5 

oo 

Sales 

"5 

00 

Sundry  cash  sales 

6 

Selling  Expense 

SO 

oo 

Cash 

50 

00 

Paid  week's  salaries  to  sales  force 

THE  SOURCE  OF  THE  LEDGER  ENTRIES 
SEPTEMBER,  1919 


125 


8 

Office  Equipment 

85 

OO 

Cash 

85 

00 

Bought  used  typewriter 

Purchases 

500 

oo 

Wilson  Bros. 

500 

00 

Bought  merchandise  on  account 

9 

« 

Cash 

15 

00 

Charles  Dwan 

15 

00 

Received    cash    in    payment    of 

Charles  Dwan's  account 

9 

Cash 

125 

oo 

Sales 

125 

oo 

Received  for  sundry  cash  sales 

10 

Administrative  Expense 

5° 

oo 

Cash 

50 

00 

•  Purchased  stamps  and  other  office 

supplies 

10 

Cash 

75 

oo 

Sales 

75 

00 

Sundry  cash  sales 

10 

J.  S.  Hanson 

55 

00 

Sales 

55 

00 

Sold  to  J.  S.  Hanson  on  account 

10 

L.  M.  Sedgwick 

80 

00 

Sales 

80 

00 

Sold  L.  M.  Sedgwick  on  account 

ii 

Purchases 

850 

oo 

Adler  Bros. 

850 

00 

Purchased  merchandise  on  account 

12 

Cash 

2S 

oo 

C.  O.  Seitz 

25 

00 

Received    from    C.    O.    Seitz    on 

account 

13 

Cluett,  Peabody  &  Co. 

750 

00 

Cash 

75° 

00 

Paid  their  invoice  of  September  5 

15 

Selling  Expense 

5° 

oo 

Administrative  Expense 

25 

00 

Delivery  Expense 

20 

oo 

Cash 

95 

oc 

Paid  salaries  for  the  week 

126  PRINCIPLES  OF  ACCOUNTING 

Posting.  The  analysis  of  the  transaction  into  its  debits  and 
credits,  as  recorded  in  the  journal  or  other  book  of  original  entry, 
facilitates  the  transfer  of  the  information  hi  to  the  accounts  which  are 
affected  by  the  transaction  hi  question.  The  process  by  which  this 
information  is  transferred  from  the  books  of  original  entry  to  the 
accounts  in  the  ledger  is  known  as  posting.  The  exact  process  of 
posting  varies  somewhat  with  the  type  of  book  of  original  entry.  In 
the  case  of  the- journal  it  consists  in  the  simple  but  laborious  process  of 
transferring  each  item  appearing  in  the  debit  money  column  of  the 
journal  to  the  debit  side  of  the  account  whose  name  appears  opposite 
that  item,  and  transferring  each  item  appearing  in  the  credit  money 
column  of  the  journal  to  the  credit  of  the  account  thus  indicated. 
A  practice  quite  often  followed  is  that  of  posting  all  the  debit  items 
to  their  proper  accounts  before  beginning  the  credit  postings.  This 
is  to  be  recommended  as  lessening  the  likelihood  of  posting  an  item 
to  the  wrong  side  of  an  account. 

When  any  item  is  posted  from  a  book  of  original  entry  into  the 
ledger,  the  page  hi  the  book  of  original  entry  from  which  the  item  is 
taken  is  entered  hi  the  folio  column  of  the  ledger  account,  and  the 
page  in  the  ledger  to  which  it  is  posted  is  entered  hi  the  folio  column 
in  the  book  of  original  entry.  This  practice  is  known  as  paging,  and 
serves  the  double  purpose  of  indicating  that  the  item  has  been  posted 
from  the  book  of  original  entry,  and  of  facilitating  any  desired  com- 
parison between  the  items  entered  in  such  record  with  the  same  items 
as  entered  in  the  ledger  accounts. 

There  is  no  stated  tune  at  which  posting  must  be  done,  so  long  as 
all  posting  is  completed  in  time  for  the  summary  and  reports  to  be 
made  at  the  end  of  a  period.  It  is  desirable,  however,  to  keep  the 
posting  as  nearly  up  to  date  as  is  practicable.  This  is  especially  true 
hi  the  case  of  personal  accounts,  and  more  particularly  the  accounts 
of  customers.  The  reasons  which  make  it  desirable  to  keep  the  latter 
class  of  accounts  up  to  date  will  be  discussed  in  chapter  xvii. 

Illustration  of  posting.  The  journal  entries  given  above  for  the 
purpose  of  illustrating  the  form  of  such  a  record  may  also  be  used  to 
illustrate  the  posting  of  journal  entries  to  the  ledger.  The  ledger 
accounts  which  would  be  affected  by  the  entries  there  shown  are 
presented  below  as  they  would  appear  after  the  posting  had  been 
completed.  In  order  to  derive  the  most  benefit  from  this  illustration, 


THE  SOURCE  OF  THE  LEDGER  ENTRIES  127 

it  is  desirable  that  the  student  should  trace  each  item  from  the  journal 
to  the  ledger  accounts. 

CASH 


Sept.    i 

4 
6 

9 

0 

10 

12 


105 

11500 
1500 

125  oo 
7500 
25  oo 


Sept.  2 
3 
3 
4 

6 

8 

10 

13 

IS 


5,00000 

7500 

35000 

6500 

800  oo 


CHARLES  DWAX 


Sept.    6 


Sept.    9    | 


1500 


C.  O.  SEITZ 


Sept.    6    45;oo      Sept.  12 

J.  S.  HANSON 

Sept.  10    „ 55  oo 

L.  M.  SEDGWICK 

Sept.  10   __ 

STORE  EQUIPMENT 

Sept.    3    «jj— i- 

DELIVERY  EQUIPMENT 

Sept.    5    800  oo 

OFFICE  EQUIPMENT 
Sept.    8    8500 


2500 


CLUETT,  PEABODY  &  COMPANY 


Sept.  13 


750  oo      Sept.    5 


7500° 


128 


PRINCIPLES  OF  ACCOUNTING 
WILSON  BROTHERS 


Sept.    8    500  oo 

ABLER  BROTHERS 

Sept.  ii    850  oo 

PAUL  NELSON,  PROPRIETOR 

Sept.    i 

SALES 

Sept.    4    105  oo 

6    15  oo 

6    45  oo 

6    115  oo 

9    125  oo 

10    7500 

10    5500 

10    So  oo 


PURCHASES 


Sept.    2 

5 

8 

ii 


5,000  oo 
750JOO 
Soojoo 
85000 


SELLING  EXPENSE 


Sept.  4 

6 

15 


65  oo 
Sojoo 
Soloo 


DELIVERY  EXPENSE 


Sept.  15 


THE  SOURCE  OF  THE  LEDGER  ENTRIES 
ADMINISTRATIVE  EXPENSE 


I2Q 


Scot.    3 

75 

oo 

10 

50 

oo 

1C 

25 

oo 

Summary.  The  books  of  original  entry  are  employed  to  record 
the  analysis  of  transactions  into  their  debits  and  credits.  This  record 
is  made  in  such  a  way  as  to  show  the  effect  of  the  transactions  on  the 
various  ledger  accounts,  and  serves  as  a  basis  for  transferring  this 
information  into  the  accounts.  The  journal  form  has  been  used  to 
illustrate  the  principles  involved  in  the  use  of  books  of  original  entry. 
Before  a  transaction  can  be  entered  in  any  book  of  original  entry,  it 
is  necessary  to  go  through  a  mental  process  of  journalization,  whereby 
the  transaction  is  analyzed  into  its  debits  and  credits.  The  journal 
form  is  used  here  for  illustration  because  the  fiorm  of  entry  in  the 
journal  sets  forth  this  fundamental  analysis  more  clearly  than  the 
form  of  entry  in  any  of  the  other  books  of  original  entry.  The  aim  of 
this  chapter  has  been  to  establish  a  familiarity  with  principles  rather 
than  with  practices.  In  subsequent  chapters  other  typical  forms  of 
books  of  original  entry  will  be  illustrated  and  their  use  explained,  and 
some  attempt  will  be  made  to  familiarize  the  student  with  current 
practice  in  the  use  of  such  records. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  J.  B.  Ames,  retail  merchant,  has  followed  the  practice  of  recording  his 
transactions  directly  in  his  ledger  accounts.     At  the  present  time  he 
has  been  unable  to  obtain  a  trial  balance  for  several  months  and  is 
unable  to  locate  the  error.     Several  customers  claim  that  the  monthly 
statements  which  he  has  sent  them  are  incorrect  and  it  has  been  quite 
difficult  for  him  to  locate  the  reason.    He  requests  you  to  explain  how 
his  records  may  be  kept  so  as  to  decrease  the  number  of  such  errors 
and  to  make  their  detection  easier.     State  what  you  would  recommend 
to  him  and  how  you  would  show  him  the  advantages  of  the  method  you 
recommend. 

2.  Upon  your  recommendation  Mr.  Ames  has  decided  to  use  a  journal  in 
which  to  record  his  transactions  before  they  go  to  the  ledger  accounts. 
He  has  never  used  a  journal  and  is  unfamiliar  with  its  ruling  and  the 
purpose  of  the  various  columns  of  the  standard  journal  page.     State 
how  you  would  explain  the  use  of  the  standard  journal  page  to  him. 


130  PRINCIPLES  OF  ACCOUNTING 

3.  It  is  also  necessary  for  you  to  explain  to  Mr.  Ames  how  he  may  transfer 
the  items  recorded  in  the  journal  to  the  ledger  accounts.     Show  by 
means  of  illustrations  how  you  would  explain  this  to  him. 

4.  How  often  should  you  suggest  to  Mr.  Ames  that  he  post  his  journal  ? 

5.  Assuming  that  customers  frequently  ask  for  the  amount  they  owe, 
what  method  may  be  followed  so  that  their  accounts  will  show  the 
amount  due  at  any  time? 

6.  If  a  customer  disputes  the  amount  of  some  item  shown  in  his  account, 
how  can  the  explanation  with  reference  to  this  item  be  easily  found  ? 

7.  Mr.  Ames  after  posting  his  ledger  is  unable  to  obtain  a  trial  balance. 
Explain  how  he  may  be  able  to  find  the  error. 

8.  Explain  the  advantages  of  the  use  of  original  records  of  entry. 

9.  Would  other  records  than  the  journal  be  desirable  in  accounting  practice  ? 
Why  ?    What  would  determine  the  nature  of  these  additional  records  ? 

REFERENCES  FOR  FURTHER  STUDY 

PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  pp.  56-61. 

KLEIN,  J.  J.,  Elements  of  Accounting,  pp.  7-12. 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xvii. 

LABORATORY  EXERCISE  NO.  26 

On  November  i,  1919,  R.  B.  Baker  made  the  following  investment  in 
the  retail  shoe  business:  cash,  $5,000.00;  a  building  valued  at  $7,500.00, 
on  a  lot  valued  at  $2,500.00. 

Nov.  3.  He  purchases  from  Hamilton  Brown  &  Co.  a  bill  of  goods 
amounting  to  $750.00,  terms  net  cash  in  thirty  days. 

4.  Pays  $450.00  for  store  equipment  and  fixtures,   including 
their  installation. 

5.  Buys  for  cash  an  office  safe,  $75.00,  and  a  typewriter,  $90.00. 

6.  Cash  sales,  $45.00. 

7.  Purchases  merchandise  from  Stacy  Adams  &  Co.,  $900.00, 
terms  net  cash  in  twenty  days. 

8.  Sells  merchandise  to  James  Ryder  on  account,  $18.00. 
Cash  sales,  $58.00. 

Pays  salaries  of  sales  clerks,  $45.00. 

10.  Purchases  from  Smith  Bros.  $600.00  for  his  note  at  thirty 
days  without  interest. 

Sells  H.  W.  Griffith  on  account,  $25.00. 

11.  Buys  office  desk  for  cash,  $40.00. 

12.  Cash  sales  for  the  past  three  days  were  $140.00. 

13.  Sells  J.  C.  Cummings  $45.00  on  account. 


THE  SOURCE  OF  THE  LEDGER  ENTRIES  131 

14.  Buys  stamps  and  stationery,  $50.00  cash. 

Pays  $20.00  to  have  a  broken  show  window  replaced. 

15.  Pays  salaries  for  the  week;  sales  salaries,  $60.00  and  office 
salaries,  $25.00. 

17.  Cash  sales  for  the  past  three  days,  $325.00. 
Sells  James  Ryder  on  account,  $32.00. 

18.  Pays  freight  and  cartage  on  goods  received,  $i8.oq. 

19.  Cash  sales,  $120.00. 

R.  B.  Baker  withdraws  for  personal  use,  $100.00. 

20.  James  Ryder  gave  his  note  for  sixty  days,  with  interest  at 
6  per  cent,  for  $50.00,  the  amount  of  his  account. 

21.  Pays  for  advertising  in  local  paper,  $50.00. 
Cash  sales,  $150.00. 

22.  Purchases  merchandise  from  Goodyear  Rubber  Co.,  $450.00, 
terms  net  cash  in  thirty  days. 

Pays  sales  salaries,  $60.00,  office  salaries.  $25.00,  delivery 
boy,  $18.00. 

24.  Pays  Hamilton  Brown  &  Co.  the  amount  of  their  invoice, 
$750.00. 

Cash  sales,  $220.00. 

25.  Purchases  a  bicycle  for  the  use  of  the  delivery  boy,  $40.00. 

26.  Receives  $45.00  from  J.  C.  Cummings,  in  payment  of  his 
account. 

29.  Cash  sales,  $300.00. 

Pays  salaries,  the  same  as  on  November  22. 

Instructions: 

Make  journal  entries  for  each  of  these  transactions,  including  a  brief 
explanation  of  each  transaction.  Use  your  own  judgment  with  regard  to 
the  accounts  which  you  will  open. 

Post  these  entries  to  the  ledger  accounts  indicated  by  the  journal  en- 
tries. Place  four  accounts  to  the  page,  with  the  exception  of  the  cash 
account,  which  should  be  placed  on  a  separate  page. 

Take  a  trial  balance. 


CHAPTER 

SOME  SPECIAL  FORMS  OF  THE  JOURNAL 

Need  of  special  books  of  record — advantages  of  their  use.  In  the 
preceding  chapter  the  nature  of  the  books  of  original  entry  was 
explained  and  some  reasons  for  their  use  set  forth.  The  journal  was 
there  illustrated  and  explained  as  the  simplest  form  of  such  a  record, 
and  the  one  best  adapted  to  aid  the  student  in  understanding  the 
fundamental  principles  of  "journalization."  As  was  there  indicated, 
it  is  possible  to  enter  all  the  transactions  of  the  business  and  get  them 
into  the  appropriate  ledger  accounts  by  means  of  the  journal  alone. 
But  accounting  experience  has  shown  that  this  would  be  too  slow  and 
laborious  a  method  of  recording  the  data  concerning  a  modern  business 
and  that  it  is  much  more  efficient  to  take  certain  classes  of  entries 
out  of  the  general  journal  and  enter  them  in  special  forms  of  books, 
each  of  which  is  designed  for  the  entry  of  transactions  falling  within 
a  certain  limited  class.  This  practice  of  segregating  certain  definite 
classes  of  transactions  into  special  books  of  original  entry,  each  of 
which  may  be  considered  as  a  subdivision  of  the  general  journal,  has 
been  carried  so  far  in  modern  accounting  practice  that  only  very  few 
types  of  entries,  including  a  very  limited  number  of  individual  items, 
are  now  made  in  the  general  journal.  What  these  types  of  entries  are 
which  still  remain  to  be  handled  in  the  journal  will  be  discussed  after 
some  consideration  has  been  given  to  the  types  of  entries  which  are 
generally  handled  by  means  of  special  books  or  records. 

In  every  business  there  are  certain  kinds  of  transactions  which 
occur  very  frequently,  for  example,  purchases,  sales,  cash  receipts, 
and  cash  disbursements.  If  all  transactions  which  fall  under  a  certain 
class  are  entered  together  in  a  special  book,  designed  for  that  purpose, 
considerable  labor  is  saved  in  entering  them  and  in  posting  them  to  the 
accounts.  Furthermore,  by  the  use  of  such  a  special  book  it  is  pos- 
sible to  obtain  additional  analysis  of  the  data,  which  would  not  be  so 
readily  obtainable  if  only  the  general  journal  were  used.  The  truth 

132 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL 


133 


of  these  statements  may  be  best  demonstrated  by  means  of  an 
illustration. 

In  any  mercantile  establishment,  one  kind  of  transaction  which 
occurs  quite  frequently  is  the  purchase  of  merchandise.  The  analysis 
of  such  a  transaction  shows  that  in  every  case  there  is  a  debit  to  be 
made  to  the  purchases  account,  and  a  credit  to  some  other  account, 
typically  to  that  of  a  trade  creditor.  If  these  purchase  transactions 
are  recorded  in  the  general  journal,  it  will  be  necessary  in  recording 
each  individual  transaction  to  indicate  both  the  debit  to  purchases 
account  and  the  credit  to  the  other  account  affected.  Assume  that 
W.  A.  Williams  makes  the  following  purchases  of  groceries  during  the 
first  week  in  September,  1919:  on  September  i,  from  Washburn- 
Crosby  Company,  $450;  on  September  2,  from  Chase  &  Sanborn, 
$300;  on  September  4,  from  the  National  Biscuit  Company,  $250; 
on  September  5,  from  Wilson  &  Company,  $300;  and  on  Septem- 
ber 6,  from  Armour  &  Company,  $275.  Omitting  the  explana- 
tions, the  entries  in  the  journal  for  these  transactions  would  appear 
as  follows: 

SEPTEMBER,  1919 


I 

Purchases 

45° 

oo 

Washburn-Crosby  Co. 

450 

00 

i 

Purchases 

300 

oo 

Chase  &  Sanborn 

300 

00 

4 

Purchases 

250 

oo 

National  Biscuit  Co. 

250 

00 

S 

Purchases 

300 

oo 

\Yilson  &  Co. 

300 

00 

6 

Purchases 

275 

oo 

Armour  &  Co. 

275 

00 

It  will  be  apparent  from  the  illustration  appearing  above  that 
there  must  be  five  separate  postings  from  the  journal  to  the  purchases 
account  for  the  five  transactions  there  shown.  The  same  results 
may  be  obtained  with  less  labor  on  the  part  of  the  bookkeeper  if  all 
the  purchase  transactions  are  kept  out  of  the  general  journal  and 


134 


PRINCIPLES  OF  ACCOUNTING 


recorded  in  a  special  book.    The  simplest  form  of  such  a  record  might 
appear  as  follows: 

MERCHANDISE  PURCHASES 


1919 

Sept. 

i 

Washburn-Crosby  Co. 

450 

oo 

3 

Chase  &  Sanborn 

300 

00 

4 

National  Biscuit  Co. 

250 

oo 

5 

Wilson  &  Co. 

300  oo 

6 

Armour  &  Co. 

275 

oo 

Purchases,  Dr. 

i,57S 

oo 

It  will  be  seen  that  in  this  form  of  record,  as  is  indicated  by  its 
heading,  only  one  class  of  transactions  is  entered.  Since  nothing  but 
merchandise  purchases  is  entered  here,  there  is  of  course  no  necessity 
of  writing  the  name  of  the  purchases  account  in  recording  each 
transaction,  since  every  transaction  is  understood  to  involve  a  debit 
to  purchases  account  and  a  credit  to  the  account  which  is  entered  in 
the  explanation  column.  Nor  is  there  any  need  of  entering  the 
amount  in  more  than  one  money  column,  since  it  is  understood  in 
each  case  that  the  amount  debited  to  purchases  is  the  same  as  that 
credited  to  the  other  account  involved.  In  posting  to  the  ledger 
accounts  from  such  a  record,  the  footing  of  the  column  would  be  posted 
to  purchases  account  as  a  total,  while  the  credits  to  the  accounts  of 
trade  creditors  would  be  posted  in  detail,  just  as  they  were  from  the 
journal.  Whether  the  number  of  the  items  of  this  class  thus  entered 
were  five  or  fifty,  there  would  be  for  any  one  accounting  period  one 
posting  of  the  total  to  the  purchases  account. 

The  foregoing  illustration  indicates  the  saving  of  labor  resulting 
from  the  use  of  a  separate  journal  or  record  hi  recording  merchandise 
purchases,  since  the  use  of  such  a  special  record  reduces  by  almost 
half  the  labor  involved  hi  the  process  of  making  the  original  entry, 
and  hi  posting.  The  same  saving  is  possible  in  the  case  of  any 
other  class  of  transactions  which  occur  at  all  frequently  in  the  conduct 
of  the  business.  In  the  ordinary  mercantile  concern  the  kinds  of 
transactions  which  are  of  most  frequent  occurrence  are  the  ones 
mentioned  in  an  earlier  paragraph  of  this  chapter:  (i)  merchandise 
purchases,  (2)  merchandise  sales,  (3)  cash  receipts,  and  (4)  cash 
disbursements.  In  almost  every  mercantile  business  these  four  classes 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL  135 

of  transactions,  and  usually  some  other  classes  as  well,  are  not  re- 
corded in  the  general  journal,  but  are  entered  on  special  forms  of 
records.  These  records  vary  somewhat  in  their  form  with  the  nature 
of  the  business  and  according  to  the  information  which  they  are 
designed  to  show.  In  the  present  chapter  the  general  nature  and  use 
of  such  books  will  be  explained,  employing  as  illustrations  very  simple 
forms  of  such  records.  These  simple  forms  will  illustrate  the 
principles  involved. 

The  purchases  journal.  It  has  already  become  apparent  that  the 
purpose  of  the  purchases  journal  is  to  record  the  purchases  made, 
showing  in  each  case  the  account  to  be  credited.  This  type  of  pur- 
chase record  is  variously  termed  "purchase  book,"  "invoice  book," 
"purchases  record,"  "purchases  register,"  and  the  like,  but  regardless 
of  what  it  may  be  called,  it  is  nothing  more  or  less  than  a  subdivision 
of  the  general  journal,  and  is,  like  all  forms  of  books  of  original  entry, 
in  the  nature  of  a  journal.  Every  entry  made  in  it  involves  an  equal- 
ity between  the  amounts  debited  and  the  amounts  credited.  For 
the  present,  then,  it  will  be  referred  to  as  the  purchases  journal. 
Also,  for  purposes  of  the  present  discussion,  it  will  be  considered  as  a 
record  of  purchases  of  merchandise  only.  Some  businesses  employ  a 
form  of  purchase  journal  in  which  every  kind  of  purchases  is  shown. 
Such  a  journal,  however,  is  usually  called  by  some  special  name, 
such  as  "vouchers  payable  register,"  "vouchers  register,"  or 
"accounts  payable  register."  No  consideration  will  be  given  such 
books  for  the  present. 

It  will  be  noted  that  in  the  foregoing  illustration  only  purchases 
on  account  were  shown.  A  question  very  naturally  arises  with  regard 
to  the  treatment  of  purchases  for  cash.  These  might  be  handled 
either  in  the  purchases  journal  or  in  the  cash  disbursements  record  or 
journal.  But  as  will  appear  hi  the  discussion  of  the  cash  records,  no 
items  affecting  cash,  whether  receipts  or  disbursements,  can  be  well 
left  out  of  the  cash  record,  and  if  cash  purchases  are  to  be  shown  in 
the  purchases  journal,  some  duplication  of  entries  will  be  involved. 
Under  some  circumstances,  as  will  be  shown  later,  it  may  be  desirable, 
for  purposes  of  obtaining  complete  information  in  the  purchases 
record,  to  show  cash  purchases  in  that  book,  but  usually  the  cash 
purchases  of  merchandise  are  so  infrequent  that  little  is  gamed  by 
recording  them  there,  and  they  are  therefore  shown  only  in  the  cash 


136 


PRINCIPLES  OF  ACCOUNTING 


record  and  posted  from  that  source.  For  the  present,  then,  the 
purchases  journal  will  be  considered  as  a  record  of  merchandise  pur- 
chased on  account. 

The  purchases  journal  illustrated.  As  has  been  intimated,  there  is 
no  one  correct  form  for  the  purchases  journal.  The  form  varies 
with  the  size  and  the  organization  of  the  business  and  with  the  nature 
and  extent  of  the  information  desired  by  the  owner  concerning 
merchandise  purchases.  Assuming  that  no  classification  of  purchases 
on  a  departmental,  commodity,  or  other  basis  is  desired  by  the  owner, 
the  information  which  should  be  generally  considered  desirable 
would  be  furnished  by  the  form  which  follows: 

PURCHASES  JOURNAL 


5 

v  a 

Date 

L.F. 

Name  of  Creditor 

Address 

Terms 

Amount 

a 

hH 

1919 

Sept. 

I 

The  Buda  Co. 

Chicago 

2/io/n/30 

85 

400 

00 

4 

Barrett-Christie  Co. 

Chicago 

2/io/n/6o 

86 

55° 

00 

8 

Simmons  Hardware  Co. 

St.  Louis,  Mo. 

n/3o 

8? 

200 

00 

12 

Gerlinger  Bros. 

Whiting,  Ind. 

2/IO/D/30 

88 

250 

00 

19 

Electric  Wheel  Co. 

Detroit.Mich. 

2/io/n/3o 

89 

45° 

00 

27 

Simmons  Hardware  Co. 

St.  Louis,  Mo. 

2/io/n/3o 

90 

34° 

oo 

30 

W.  F.  Hebard  Co. 

Chicago 

2/io/n/30 

225 

oo 

30 

Total  (Purchases,  Dr.) 

2,415 

00 

The  columns  shown  in  the  foregoing  illustration  are,  with  their 
headings,  for  the  most  part  self-explanatory.  Three  of  them,  how- 
ever, may  require  a  few  words  of  explanation.  The  column  headed 
"L.F."  is  used  to  record  the  page  in  the  ledger  of  the  account  to  which 
the  credit  for  the  purchase  transaction  is  posted  in  each  case,  such 
account  being  the  same  as  the  name  of  the  creditor  written  in  the  next 
column.  The  column  headed  "Terms"  needs  no  explanation  to 
those  at  all  familiar  with  business  practice.  It  is  used  to  show  the 
credit  terms  upon  which  the  goods  are  purchased.  Thus  "  2/io/n/3o" 
means  that  the  purchaser  will  be  allowed  to  deduct  2  per  cent  from  the 
price  stated  in  the  invoice  if  he  pays  it  within  ten  days,  and  that  in 
any  case  he  is  not  supposed  to  delay  paying  for  the  goods  for  more  than 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL  137 

thirty  days.  The  column  headed  "Invoice  Number"  is  to  record  the 
number  of  the  "invoice"  or  statement  of  the  shipment  of  goods, 
which  shows  the  items  shipped,  their  prices,  the  terms  of  payment,  and 
other  information.  The  handling  of  the  invoice  will  be  discussed 
in  more  detail  later.  The  invoice  number  in  connection  with  the 
entry  of  the  transaction  is  useful  in  case  any  question  arises  later 
which  makes  desirable  more  information  concerning  the  transaction, 
or  which  requires  a  verification  of  the  information  in  the  purchases 
journal.  It  is  still  the  custom  in  some  businesses  to  enter  in  the 
purchases  book  practically  all  the  detail  that  is  shown  on  the  invoice 
for  each  transaction.  This  adds  greatly  to  the  size  of  the  book  and  is 
a  laborious  process,  besides  being  quite  unnecessary.  Modern  prac- 
tice depends  on  the  invoices,  which  are  filed  in  some  logical  order,  to 
furnish  any  such  details  as  are  needed,  the  invoice  number  in  the 
purchases  book  serving  as  a  reference  to  the  invoice  in  question. 

Posting  from  tlte  purchases  journal.  Posting  from  the  purchases 
journal  is  simpler  than  the  posting  from  the  general  journal.  It 
consists  in  transferring  the  total  of  the  "amount"  column  to  the 
debit  of  purchases  account,  and  in  transferring  the  amount  of  each  of 
the  items  to  the  credit  of  the  account  named  in  the  column  headed 
"Name  of  Creditor."  It  is  generally  desirable  to  keep  the  accounts 
with  creditors  posted  up  to  date,  so  that  information  concerning  their 
claims  may  be  readily  obtained  at  any  time.  For  this  reason  such 
accounts  should  be  posted  daily.  This  posting  is  often  made  directly 
from  the  purchase  invoice,  after  the  latter  has  been  used  as  a  basis  for 
entering  the  transaction  in  the  purchases  journal  and  stamped  to 
indicate  that  such  entry  has  been  made.  The  routine  of  handling 
the  purchase  and  sales  invoices  and  using  them  as  posting  media  will 
be  discussed  at  length  in  the  chapters  on  business  vouchers  and 
forms  (see  chapter  xiv),  and  in  the  chapters  on  purchases  and  sales 
(see  chapter  xvii).  The  posting  of  the  total  of  the  "amount"  column 
to  the  purchases  account  can  only  be  made  when  that  column  is 
totaled,  and  this  is  usually  done  only  at  the  time  when  a  trial  balance 
is  to  be  taken,  which  is  generally  at  the  close  of  each  month.  The 
illustration  of  the  purchases  journal  shown  above  indicates  the  method 
of  ruling  the  purchases  journal  after  such  a  posting  has  been  made.  The 
number  of  the  ledger  page  of  each  creditor's  account,  or  some  other 


138  PRINCIPLES  OF  ACCOUNTING 

form  of  check  on  the  posting,  would  appear  in  the  folio  column  oppo- 
site the  name  of  the  account,  and  the  page  number  of  the  purchases 
account  would  appear  opposite  the  last  item,  "Purchases,  Dr." 

The  sales  journal.  The  sales  journal  is  a  special  form  of  record 
whose  purpose  is  to  provide  a  record  of  the  transactions  involving  sales 
of  merchandise  by  the  business.  It  may  be  used  to  record  all  sales  of 
merchandise,  whether  for  cash,  on  open  account,  or  for  notes.  On 
the  other  hand,  it  is  often  used  to  record  only  sales  on  account.  In  a 
wholesale  business,  where  the  sales  are  relatively  few  in  number  and 
large  hi  amount,  it  is  quite  practicable  to  record  all  sales  in  the  sales 
journal,  treating  them  all  as  credit  sales,  even  though  actually  made 
for  cash,  and  in  the  case  of  cash  sales  to  debit  cash  and  credit  the 
customer  by  means  of  an  entry  in  the  cash  journal  made  at  the  same 
time.  In  a  retail  business,  where  there  are  a  large  number  of  cash 
sales,  often  for  small  amounts,  such  a  procedure  is  not  practicable, 
and  here  the  cash  sales  are  ordinarily  entered  in  the  cash  journal  and 
posted  to  the  sales  account  from  that  record,  while  only  sales  on 
account  are  entered  in  the  sales  journal.  On  account  of  the  large  num- 
ber of  individual  sales  in  a  retail  establishment,  both  cash  and  credit 
sales  would  usually  be  entered  in  total  at  the  end  of  the  day,  the  totals 
being  obtained  by  listing  and  adding  the  amounts  of  the  sales  tickets, 
and  the  posting  to  the  customers'  accounts  in  the  case  of  credit  sales 
would  in  this  case  be  made  direct  from  the  sales  tickets. 

To  make  sure  that  the  student  understands  the  first  method  of 
procedure  described  above,  an  illustration  will  be  given.  Suppose 
that  the  National  Biscuit  Company  sells  W.  A.  Williams,  a  retail 
merchant,  merchandise  to  the  value  of  $400,  for  which  he  pays  cash. 
According  to  the  method  outlined  above,  the  entries  made  by  the 
wholesale  concern  to  record  this  transaction,  if  put  hi  journal  form, 
would  appear  as  follows: 

W.A.Williams $400.  oo 

Sales $400.00 

Cash 400.00 

W.  A.  Williams $400.00 

If  the  student  will  picture  in  his  mind  the  effect  of  these  entries 
on  the  accounts,  it  will  be  clear  that  the  customer's  account  is  hi  no 
way  changed  by  the  entry  except  to  increase  the  total  of  each  side, 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL 


139 


and  that  the  net  effect  of  the  entry  is  a  debit  to  cash  and  a  credit  to 
sales.  But  since  these  entries  are  not  actually  made  in  the  journal, 
but  in  two  separate  books,  and  usually  by  two  different  persons,  it  is 
really  more  convenient  to  have  them  recorded  in  this  manner  than  it 
would  be  to  try  to  combine  the  record  of  the  transaction  into  one  entry. 

The  sales  record,  like  the  purchases  record,  is  known  by  a  number 
of  different  titles,  being  variously  called  "sales  record,"  "sales  book," 
"sales  register,"  etc.  The  name  is  immaterial  so  long  as  the  nature 
of  the  record  is  understood.  It  will  be  known  here  as  the  sales  journal, 
since  that  is  the  name  which  seems  best  to  indicate  its  real  nature. 

Illustration  of  sales  journal.  It  was  stated  on  page  1 20  that  the 
form  of  the  purchases  journal  would  vary  considerably  in  different 
business  establishments  according  to  the  amount  of  analysis  and 
detailed  information  desired  by  the  managers  concerning  the  pur- 
chases. There  are  more  possible  bases  which  may  seem  desirable  for 
analyzing  sales  than  there  are  in  the  case  of  purchases.  The  form  of 
the  sales  journal  may  therefore  vary  still  more  widely  than  that  of  the 
purchases  journal.  The  matter  of  sales  analysis  by  means  of  the  sales 
journal  must  be  left  for  consideration  in  a  later  chapter.  Omitting 
that  for  the  present,  a  simple  form  of  sales  journal  which  would  furnish 
the  essential  information  might  appear  as  follows: 

SALES  JOURNAL 


b 

jo 

Date 

LF. 

Name  of  Customer 

Address 

Terms 

•-  I 

Amount 

>Z 

a 

1920 

Jan. 

I 

D.  F.  Anderson 

624  Ninth  Ave.,  S.E. 

X 

45 

00 

3 

H.  Schroeder 

1525  University  Ave. 

2 

27 

50 

5 

Paul  Carroll 

2408  Fourth  St.,  S.E. 

3 

18 

00 

7 

P.  Hathaway 

945  Oak  St. 

4 

22 

50 

10 

F.  K.  Enke 

1214  Fourth  St.,  S.E. 

5 

28 

00 

15 

Oliver  Eames 

2546  University  Ave. 

6 

35 

00 

10 

R.  B.  McCall 

468  Sanborn  Ave. 

7 

24 

50 

J.  H.  Gray 

1278  Riverside  Blvd. 

8 

47 

50 

30 

P.  Hathaway 

945  Oak  St. 

9 

25 

40 

Sales,  credit 

273 

40 

In  view  of  the  explanations  already  given  of  the  use  of  the  columns 
in  the  journal  and  the  purchase  journal,  it  is  not  necessary  to  explain 


140  PRINCIPLES  OF  ACCOUNTING 

the  use  of  the  foregoing  columns.  The  ledger  folio  column  will  be  used, 
of  course,  when  the  debits  to  customers  are  posted  to  their  accounts. 
It  will  be  noted  that  the  column  headed  "Terms"  is  left  blank  in  this 
illustration.  The  reason  is  that  the  business  involved  is  assumed  to  be 
a  retail  business,  and  in  such  a  business  all  goods  are  usually  sold 
either  for  cash  or  on  "monthly  account,"  the  balance  of  each  cus- 
tomer's account  being  payable  at  the  end  of  each  month.  This  being 
the  case,  a  statement  of  terms  of  sale  is  superfluous.  This  column 
would  be  used  in  the  case  of  a  manufacturing  or  wholesale  mercantile 
concern,  since  such  concerns  sell  goods  which  are  to  be  paid  for  within 
a  definite  number  of  days  after  the  date  of  the  invoice,  usually  with  the 
privilege  of  deducting  a  discount  for  payment  within  a  stated  shorter 
tune. 

Posting  from  the  sales  journal.  The  method  of  posting  from  the 
sales  journal  is  similar  to  that  described  on  page  137  for  the  purchases 
journal.  The  total  of  the  "Amount"  column  is  posted  to  the  credit  of 
the'  sales  account.  Each  of  the  items  in  that  column  is  posted  to  the 
debit  of  the  customer  whose  name  appears  in  the  column  headed  "  Name 
of  Customer."  The  total  of  the  sales  will  be  posted  to  the  sales  account 
only  at  the  tune  when  a  trial  balance  is  to  be  taken,  but  the  debits  to 
the  customers'  accounts  should  be  posted  daily.  This  is  especially 
true  in  a  manufacturing  or  wholesale  business  where  customers  may 
wish  to  extend  their  credit  to  a  considerable  amount.  In  passing  on 
the  granting  of  credit  to  a  customer,  the  particular  manager  who  is 
responsible  for  credit  and  collections  will  require  all  the  data  which  are 
available  with  regard  to  that  customer,  and  this  will,  of  course,  include 
the  standing  of  his  account  at  that  date.  Also,  whether  or  not 
accounts  are  posted  daily,  they  must  be  posted  in  time  to  prepare  the 
periodical  statements  of  account  which  are  sent  out  by  many  wholesale 
houses  and  by  practically  all  retail  houses  to  their  customers. 

The  cash  journals.  In  most  businesses  the  transactions  involving 
cash  are  of  the  most  frequent  occurrence.  Such  transactions  are 
really  of  two  kinds:  (i)  those  involving  the  receipt  of  cash  and  (2) 
those  involving  the  disbursement  of  cash.  There  is  ordinarily  found 
in  use,  therefore,  a  special  form  of  journal  for  each  of  these  types  of 
transactions.  Each  of  these  records  is,  of  course,  a  complete  and 
separate  journal,  but  the  two  are  generally  both  included  in  keeping 
a  complete  record  of  cash,  this  record  being  known  as  the  "  cash  book." 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL 


All  through  this  book  the  two  forms  are  bound  together,  so  that  on 
the  left-hand  page  is  shown  the  record  of  the  receipts  of  cash,  and  on 
the  right-hand  side  the  record  of  the  cash  disbursements.  Since 
every  transaction  involving  the  receipt  of  cash  means  a  debit  to  the 
cash  account  and  every  one  involving  a  disbursement  means  a  credit 
to  that  account,  this  arrangement  of  the  cash  book  is  hi  accord  with 
the  practice  observed  elsewhere  of  recording  debits  on  the  left  side 
of  the  account  and  in  the  left-hand  money  column  of  the  journal. 
These  two  forms  of  record,  then,  while  each  a  complete  journal  in 
itself,  constitute  the  two  sides  of  the  cash  book,  the  left-hand  page, 
showing  the  receipts,  being  known  as  the  debit  side,  and  the  right-hand 
page,  showing  disbursements,  being  known  as  the  credit  side. 

Form  of  the  cash  book.  Like  the  sales  journal,  purchases  journal, 
and  other  special  forms  of  books  of  original  entry,  the  cash  book  may 
be  used  to  show  a  considerable  amount  of  detail  in  analyzing  the 
transactions  involved.  The  extent  to  which  such  detail  will  be  shown 
will  depend  on  the  reporting  requirements  of  the  management.  For 
the  present  it  is  best  to  illustrate  the  principles  involved  in  the  use  of 
such  a  record  by  a  very  simple  form  of  cash  book,  such  as  might  be 
suitable  for  a  small  mercantile  business  with  a  limited  range  of  trans- 
actions and  simple  reporting  requirements.  Such  a  form  might  be 
ruled  as  follows: 

CASH  RECEIPTS 


Date 

L.F. 

Account  Credited 

Explanation 

Amount 

Total 
,  Cash,  Dr. 

Jan. 

i 

George  Dailey,  Cap. 

Investment 

7,500 

oo 

2 

Sales 

Cash  sales 

85 

00 

5 

H.  Schroeder 

In  full  of  account 

2750 

9 

Sales 

Cash  sales 

122  50 

15 

D.  F.  Anderson 

In  full  of  account 

45 

00 

21 

Notes  receivable 

D.  Gray's  note  11/22 

20000 

21 

Interest  on   notes  re- 

D. Gray's  note  11/22 

2 

00 

ceivable 

27 

Sales 

Cash  sales 

US 

oo 

30 

R.  B.  McCall 

In  full  of  account 

24 

50 

31 

Cash,  Dr. 

8,151 

50 

Feb. 

I 

Balance  on  hand 

8,151 

5° 

6,584 

00 

142 


PRINCIPLES  OF  ACCOUNTING 
CASH  DISBURSEMENTS 


Date 

L.F. 

Account  Debited 

Explanation 

Amount 

Total 
Cash,  Cr. 

Jan. 

I 

Prepaid  insurance 

Paid  insurance  for  yr. 

72 

oo 

3 

Rent 

Rent  of  store  for  Jan. 

90 

00 

6 

Sales  salaries 

Pay-roll  for  week 

75 

oo 

6 

Office  salaries 

Pay-roll  for  week 

*5 

oo 

10 

Purchases 

Buda  Co.  for  cash 

125 

50 

13 

Sales  salaries 

Pay-roll  for  week 

75 

00 

18 

Simmons  Co. 

Invoice  1/8 

200 

oo 

24 

Office  equipment 

Typewriter  and  desk 

125 

oo 

28 

Electric  Wheel  Co. 

Invoice  1/19 

45° 

oo 

30 

30 

Office  supplies 
Advertising 

Stationery  &  printing 
Ad.  in  Daily  News 

80 

25 

oo 
oo 

3i 

Office  salaries 

Salaries  to  date 

75 

00 

3i 

Sales  salaries 

Salaries  to  date 

15° 

oo 

31 

Cash,  Cr. 

1,567 

So 

3i 

Balance  on  hand 

6,584 

00 

8,151 

5° 

Nature  of  the  cash  book.  Although  the  two  sides  of  the  cash  book 
are  practically  always  shown  bound  together  so  that  they  fall  on 
alternate  and  opposite  pages,  and  must  both  be  taken  together  in 
order  to  have  a  complete  record  of  cash,  it  is  well  for  the  student  to 
remember  that  they  are  in  reality  two  complete  journals.  That  is 
to  say,  each  of  these  two  forms  provides  for  a  complete  record  of  the 
transaction  to  be  recorded,  with  an  equality  between  the  debits  and 
the  credits  for  each  such  entry.  This  equality  between  debits  and 
credits  may  not  be  apparent  from  a  glance  at  either  of  the  cash  jour- 
nals, but  it  becomes  apparent  when  the  posting  is  considered.  Thus, 
if  H.  Schroeder  pays  $27.50,  the  amount  of  his  account  with  the 
business,  the  journalization  of  the  entry  as  it  would  appear  in  the 
general  journal  is  as  follows: 

Cash $27.50 

H.  Schroeder $27.50 

Here,  of  course,  the  equality  of  debit  and  credit  is  quite  apparent. 
But  when  this  transaction  is  recorded  in  the  cash  receipts  journal,  or 
debit  side  of  the  cash  book,  the  amount  will  only  be  entered  once, 
according  to  the  illustration  given  above.  The  reason  for  this  is  that 
the  total  of  all  items  entered  on  this  record  is  understood  to  be  a 
debit  to  cash,  and  this  total  will  be  posted  as  a  single  item  at  the  end 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL  143 

of  the  accounting  period,  so  that  there  will  be  an  equality  between  the 
debits  and  credits  posted  to  the  ledger  from  this  journal,  since  the 
total  amount  debited  to  cash  is  the  sum  of  all  the  individual  items 
credited  to  other  accounts. 

It  is  easy  to  see  that  the  same  is  true  of  the  other  side  of  the  cash 
book,  on  which  the  disbursements  are  recorded.  Here  each  entry 
involves  a  credit  to  cash  and  an  equal  debit  to  some  other  account  or 
accounts.  The  debits  will  be  posted  separately,  item  by  item,  while 
the  credit  to  cash  will  be  obtained  from  the  footing  of  the  "amount" 
column.  The  total  of  the  items  debited  to  other  accounts  must  be 
equal  to  the  amount  of  the  credit  to  cash,  since  this  is  also  the  total 
of  the  items  entered  in  the  "amount"  column. 

Both  the  record  of  cash  receipts  and  the  record  of  cash  disburse- 
ments, then,  like  the  purchases  journal  and  the  sales  journal,  are 
special  forms  of  the  journal,  each  dealing  with  a  particular  kind  of 
transaction.  Every  entry  made  in  either  of  them  is  complete  hi  its 
analysis  of  the  transaction  into  debits  and  credits,  and  the  principles 
involved  in  the  use  of  these  forms  are  in  no  way  different  from  those 
governing  the  use  of  the  general  journal. 

.  Posting  the  cash  book.  The  posting  of  the  cash  book  should  be 
sufficiently  indicated  by  the  foregoing  discussion,  taken  in  connection 
with  the  instructions  for  the  posting  of  the  purchases  book  and  sales 
book.  On  the  debit  side  the  individual  items  appearing  in  the 
"amount"  column  are  to  be  posted  to  the  credit  of  the  accounts 
indicated  in  the  column  headed  "account  credited,"  while  the  total  of 
the  "amount"  column  goes  to  the  debit  of  the  account  with  cash. 
On  the  credit  side  the  items  are  posted  to  the  debit  of  the  different 
accounts  indicated,  and  the  total  to  the  credit  of  cash. 

Summary.  The  discussion  in  the  present  chapter  has  as  its 
object  the  explanation  of  the  general  principles  involved  in  the  use  of 
special  journals.  For  this  reason  it  is  not  considered  desirable  to  risk 
confusing  the  student  by  introducing  at  this  point  any  but  the  very 
simplest  forms  of  such  books.  As  a  matter  of  fact,  such  simple  forms 
as  the  ones  here  presented  are  usually  found  only  in  very  small  or 
simply  organized  businesses.  Most  of  the  records  are  much  more 
elaborate,  in  order  better  to  serve  the  purposes  of  labor  saving  and 
analysis  of  information.  Illustrations  of  such  forms,  with  a  discussion 
of  the  principles  governing  their  design,  will  be  presented  in  chapters 


144  PRINCIPLES  OF  ACCOUNTING 

xix  and  xx.  For  the  present  the  student  should  secure  a  clear 
understanding  of  the  connection  between  the  books  of  original  entry 
and  the  reporting  requirements  of  the  business.  That  connection 
may  be  briefly  stated  as  follows:  In  any  given  business  there  are 
certain  items  of  information  which  it  is  desirable  to  have  presented  in 
periodical  reports.  In  order  to  have  these  items  of  information 
available  when  needed,  it  is  well  to  keep  a  continuous  record  of  the 
changes  taking  place  in  each  of  these  items  in  the  form  of  an  account 
with  such  an  item.  The  number  of  such  accounts  required  by  the 
business,  and  the  nature  of  the  information  to  be  shown  in  these 
accounts,  will  determine  the  number  and  form  of  the  books  of  original 
entry  designed  to  show  the  analysis  of  the  business  transactions 
according  to  their  effect  upon  the  various  accounts.  If  the  student 
can  clearly  see  this  relation  as  applied  to  the  simple  forms  of  records 
so  far  used  for  illustrations,  he  should  have  little  difficulty  in  under- 
standing, using,  and  designing  the  more  complicated  forms  which  will 
be  considered  in  later  chapters. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  The  X.  Y.  Mercantile  Company  makes  numerous  purchases  of  farm 
products,  both  on  account  and  for  cash.    What  method  would  you 
recommend  for  recording  these  purchases  ?    Would  you  record  the 
purchases  on  account  and  cash  purchases  in  the  same  book  ?     Why,  or 
why  not  ? 

2.  The  bookkeeper  for  the  X.  Y.  Company  says  that  the  purchases  of  pro- 
duce on  account  have  always  been  entered  in  the  general  journal,  and 
wishes  to  continue  the  practice.     Explain  just  why  it  would  be  to  his 
interest  to  use  a  different  method. 

3.  Most  of  the  farmers  who  sell  produce  to  the  X.  Y.  Mercantile  Company 
later  purchase  merchandise  from  the  company  to  an  amount  not  greatly 
different  from  the  amount  of  the  produce  sales.    What  .record  would 
be  made  when  the  sales  take  place  ? 

4.  The  X.  Y.  Mercantile  Company  decides  to  issue  "due  bills"  to  those 
from  whom  they  purchase  produce.    These  "due  bills "  will  be  returned 
later  in  payment  of  merchandise.    Explain  the  accounting  procedure 
involved  in  establishing  this  practice. 

5.  Describe  the  procedure  followed  in  posting  from  the  purchases  journal. 
^  By  what  other  names  is  this  book  sometimes  called? 

6.  Can  the  form  of  sales  journal  illustrated  in  chapter  xii  be  used  to  record 
cash  sales  ?    Explain. 

7.  A  form  of  sales  record  formerly  used  was  a  large  book,  into  which  the 
sales  invoices  were  pasted.    This  is  now  obsolete.    Why  should  this 
be  so  ?  Is  less  information  concerning  sales  required  now  than  formerly  ? 


SOME  SPECIAL  FORMS  OF  THE  JOURNAL  145 

8.  Describe  the  procedure  followed  in  posting  from  the  sales  journal. 

9.  Is  the  "cash  book"  one  or  two  journals?    Describe  its  posting. 

10.  Jones  &  Wilson  give  the  Citizens  State  Bank  their  note  for  $1,000.00 
at  sixty  days,  without  interest.  The  bank  discounts  the  note  at  6 
per  cent,  and  credits  their  account  with  $990.00.  How  could  this 
transaction  be  recorded  in  the  form  of  cash  book  which  has  been 
described  ? 

n.  Explain  what  is  necessary  in  order  that  customers'  accounts  may  show 
at  any  time  the  amount  which  they  owe. 

12.  Mention  as  many  special  journals  as  you  can  which  might  be  used  by 
different  businesses,  and  explain  the  purpose  of  each. 

REFERENCES  FOR  FURTHER  STUDY 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  xviii-xxi. 
KLEIN,  J.  J.,  Elements  of  Accounting,  pp.  12-15. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  v. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  pp.  77-93. 

LABORATORY  EXERCISE  NO.  27 

The  following  are  the  purchases  of  H.  F.  Ford  during  the  month  of  May: 
May    2.  Bought  of  King  Mercantile  Co.,  terms  n/io,  merchandise, 
$480.50. 

3.  Bought  of  Hodge  &  Lyon,  terms  n/io,  merchandise,  $370.40. 

4.  Bought  from  0.  P.  Read,  terms  n/3o,  merchandise,  $1,640.40. 
18.  Bought  of  King  Mercantile  Co.,  terms  n/3o,  merchandise, 

$950.60. 

25.  Bought  of  Hodge  &  Lyon,  terms  n/3o,  merchandise,  $450.80. 

26.  Bought  of  Lane  Shoe  Co.,  terms  n/3o,  merchandise,  $750.40. 

30.  Bought  of  J.  C.  Adams,  terms  n/6o,  merchandise,  $340.60. 

31.  Bought  of  O.  P.  Read,  terms  n/3o,  merchandise,  $480.20. 
Instructions: 

Rule  a  sheet  of  paper  to  represent  a  purchases  journal  and  enter  the 
foregoing  transactions. 

Preserve  this  exercise  for  future  use. 

LABORATORY  EXERCISE  NO.  28 

The  following  are  the  sales  of  H.  F.  Ford  during  the  month  of  May: 
May    i.  Sold  J.  O.  Murdock,  215  Main  St.,  merchandise,  $13.00. 

4.  Sold  L.  L.  Koelsch,  5714  Blackstone  Ave.,  merchandise,  $16.50. 
9.  Sold  M.  J.  Torr,  4674  University  Ave.,  merchandise,  $34.00. 

12.  Sold  N.  W.  Barnes,  5742  Dorchester  Ave.,  merchandise,  $8.00. 

15.  Sold  W.  E.  Atkins,  6048  Woodlawn  Ave.,  merchandise,  $22.00. 

18.  Sold  C.  0.  Hardy,  6140  University  Ave.,  merchandise,  $19.00. 

21.  Sold  J.  C.  Christ,  5842  Woodlawn  Ave.,  merchandise,  $28.00. 

26.  Sold  A.  M.  Rogers,  4872  Main  St.,  merchandise,  $16.00. 

30.  Sold  J.  D.  Holmes,  6175  King  St.,  merchandise,  $26.00. 


146  PRINCIPLES  OF  ACCOUNTING 

Instructions: 

Rule  a  sheet  of  paper  to  represent  a  sales  journal  and  enter  the  foregoing 
transactions. 

Preserve  this  exercise  for  future  use. 

LABORATORY  EXERCISE  NO.  29 

The  following  are  the  cash  transactions  of  H.  F.  Ford  during  the  month 
of  May: 

May    i.  H.  F.  Ford  invests  $2,600.00  cash  in  the  retail  merchandise 
business. 

2.  Bought  of  A.  M.  Hall  for  cash,  stock  of  merchandise,  invoiced 
at  $1,740.60. 

3.  Paid  rent  for  the  month,  $50.00. 
Received  from  cash  sales,  $80.40. 

5.  Paid  clerk  hire,  $18.00. 

6.  Received  $13.00  from  J.  0.  Murdock  hi  full  of  account. 

8.  Paid  King  Mercantile  Co.  $480 . 50  in  full  of  account. 

9.  Received  $280.40  for  cash  sales. 

12.  Paid  clerk  hire,  $20.00. 

13.  Paid  $28.00  for  expenses  of  buying  trip. 

16.  Purchased  delivery  equipment  for  cash,  $210.00. 

17.  Paid  Hodge  &  Lyon  $370.40  in  full  of  account. 

17.  Received  $16.50  from  L.  L.  Koelsch  in  full  of  account. 

1 8.  Paid  $12.20  for  stamps  and  stationery. 

19.  Paid  clerk  hire,  $21.00. 

22.  Received  from  M.  J.  Torr  $34.00  hi  full  of  account. 
24.  Received  from  C.  O.  Hardy  $19.00  in  full  of  account. 

26.  Received  $640.20  for  cash  sales. 
Paid  salary  of  delivery  clerk,  $18.00. 

27.  H.  F.  Ford  withdrew  for  personal  use,  $25.00. 

29.  Received  from  N.  W.  Barnes  $8.00  in  full  of  account. 
31.  Received  $420.80  for  cash  sales. 

Paid  miscellaneous  administrative  expenses,  $42.00. 
Instructions: 

Using  a  double  sheet  of  journal  paper  as  a  cash  book,  enter  the  fore- 
going transactions. 

LABORATORY  EXERCISE  NO.  30 

Exercises  Nos.  27,  28,  and  29  together  constitute  the  purchase,  sales, 
and  cash  transactions  of  H.  F.  Ford  for  the  month  of  May.     Post  the 
records  prepared  in  the  three  exercises,  placing  four  accounts  to  the  page. 
Take  a  trial  balance. 


CHAPTER  XIII 

THE  USE  OF  THE  GENERAL  JOURNAL 

Effect  of  special  journals  on  the  general  journal.  In  discussing  the 
books  of  original  entry  in  chapter  x  the  general  journal  was  explained 
and  illustrated  as  a  posting  medium  for  transactions  of  all  kinds.  It 
was  stated  at  that  time,  however,  that  this  journal  was  not  so  em- 
ployed in  modern  practice.  It  was  used  in  chapter  x  merely  to  illus- 
trate in  a  simple  way  the  nature  and  function  of  books  of  original 
entry  and  the  method  of  recording  transactions  in  them.  In  chapter 
xii,  special  journals  for  record  ingtransactions  with  purchases,  sales,  and 
cash  were  discussed  and  illustrated.  These  journals  were  discussed 
because  they  are  the  ones  in  general  use,  although  many  other  special 
journals  are  found  in  use  in  various  businesses,  and  because  they  are 
typical  of  all  special  journals. 

By  the  use  of  these  journals  three  principal  classes  of  transactions 
are  taken  out  of  the  general  journal  and  entered  in  these  separate 
records.  An  analysis  of  the  transactions  of  a  mercantile  business  will 
show  that  most  of  its  transactions  involve  the  purchase  or  sale  of 
merchandise  or  the  receipt  or  payment  of  cash.  Since  this  is  true, 
it  is  interesting  to  inquire  what  transactions  are  left  to  be  recorded  in 
the  journal,  which,  as  previously  stated,  is  used  to  record  all  trans- 
actions not  placed  in  any  special  journal.  For  the  sake  of  discussion 
the  entries  recorded  in  the  journal  may  be  classified  as  follows:  (i) 
opening  entries;  (2)  current  entries;  (3)  adjusting  entries;  (4) 
closing  entries.  In  order  that  the  present  use  of  the  journal  as  a 
posting  medium  may  be  better  understood,  each  of  these  will  be 
discussed  in  turn. 

Opening  entries.  Opening  entries  are  those  which  are  made  to 
record  the  financial  condition  of  the  business  at  the  time  of  its  begin- 
ning or  organization.  The  financial  condition  of  a  business  is  shown 
by  its  assets  and  liabilities  and  the  difference  between  the  two,  which 
is  its  net  worth.  The  opening  entry  or  entries  must  record  these  so 
that  they  will,  when  posted,  be  properly  shown  in  the  accounts.  In 

147 


148 


PRINCIPLES  OF  ACCOUNTING 


the  case  of  a  sole  proprietor,  his  investment  may  consist  entirely  of 
cash,  in  which  case  the  opening  entry  may  be  made  through  the  cash 
book  by  a  debit  to  cash  and  a  credit  to  the  proprietor's  account. 

In  many  cases  the  proprietor  has  other  property,  such  as  land, 
buildings,  and  merchandise  which  he  desires  to  invest  in  the  business, 
in  which  case  a  journal  entry  must  be  made,  since  these  items  cannot 
be  recorded  in  the  special  journals. 

For  purposes  of  illustration  it  may  be  assumed  that  on  June  i, 
1918,  J.  R.  Bell  started  in  business  by  investing  the  following 
assets:  cash,  $1,000;  merchandise,  $2,000;  building,  $4,000;  land, 
$1,000.  By  adding  these  items  it  will  be  seen  that  the  total  assets  of 
Bell  are  $8,000,  and  since  he  has  no  liabilities  this  amount 
represents  his  proprietorship  or  net  worth.  Bell's  books  may  be 
opened  by  the  following  journal  entry: 


Cash 

1,000 

oo 

Merchandise  Inventory 

2,000 

oo 

Building 

4,000 

00 

Land 

1,000 

00 

J.  R.  Bell,  proprietor 

8,000 

00 

Although  the  posting  of  this  entry  will  show  Bell's  financial 
condition  hi  the  accounts,  all  cash  must  be  recorded  in  the  cash  book, 
consequently  the  cash  item  will  be  recorded  on  the  debit  side  of  the 
cash  book  as  well  as  in  the  journal.  It  is  readily  apparent  that  this 
item  cannot  be  posted  from  both  the  journal  and  the  cash  book,  for 
if  it  is  it  would  show  a  cash  investment  of  $2,000  instead  of  $1,000. 
To  avoid  this,  the  individual  item  is  not  posted  from  either  book. 
It  is  included  in  the  total  of  $8,000  which  is  posted  from  the  journal 
to  the  credit  of  Bell's  account  and  it  will  be  included  in  the  cash 
total  posted  from  the  cash  book  to  the  debit  of  the  cash  account. 
Another  method  of  treating  this  item  is  not  to  enter  it  in  the  journal, 
but  only  hi  the  cash  book,  and  to  post  it  from  there.  The  advantage 
of  ^ntering  it  hi  the  journal  is  that  the  total  investment  is  shown  in 
one  place.  Both  methods  give  the  same  result  so  far  as  the  effect 
on  the  accounts  and  the  reports  is  concerned. 

In  some  cases  the  proprietor  has  liabilities  at  the  inception  of  the 
business  which  he  desires  the  business  to  assume.  In  this  case  these 


THE  USE  OF  THE  GENERAL  JOURNAL 


149 


liabilities  must  be  shown  as  part  of  the  journal  entry.     If  Bell 
owes  $  1,000  on  account  to  creditors,  his  opening  entry  would  be: 


Cash 

1,000 

oo 

Merchandise  Inventory 

2,000 

oo 

Building 

4,000 

oo 

Land 

1,000 

oo 

Accounts  payable 

1,000 

00 

J.  R.  Bell,  proprietor 

7,000 

00 

The  cash  item  will  be  treated  in  this  case  in  the  same  manner  as 
explained  above. 

The  example  just  given  illustrates  the  nature  of  the  opening  entries 
for  a  single  proprietor.  The  same  principles  are  followed  in  the  case 
of  a  partnership  or  of  a  corporation,  but  the  entries  may  be  somewhat 
more  complicated.  The  method  of  making  such  entries  will  be 
explained  and  illustrated  in  subsequent  chapters. 

Current  entries.  As  previously  stated,  the  general  journal  is  used 
to  record  all  transactions  which  cannot  wisely  be  recorded  in  any  of 
the  special  journals.  It  is  impossible  to  discuss  all  such  transactions 
which  may  arise  during  the  fiscal  period  in  connection  with  different 
businesses,  but  a  few  which  occur  most  frequently  will  be  considered. 

In  the  discussion  of  the  purchases  and  sales  journals  it  has  been 
explained  that  these  records  are  used  only  to  record  purchases  and 
sales  of  merchandise.  In  every  business  certain  property  other  than 
salable  merchandise  must  be  purchased  from  time  to  time  to  use  in 
the  conduct  of  the  business.  Then,  too,  discarded  property,  or  prop- 
erty no  longer  needed  in  the  conduct  of  the  business,  may  be  sold. 
If  these  purchases  and  sales  are  for  cash  they  may  be  recorded  in  the 
cash  book,  but  if  they  are  on  account  the  only  means  of  recording 
them  is  in  the  journal.  For  instance,  if  $600  of  office  equipment  is 
purchased  on  account  from  the  Brown  Furniture  Company  the  asset 
account  with  office  equipment  should  be  debited  and  the  account 
of  the  Brown  Furniture  Company  should  be  credited.  This  is  accom- 
plished by  the  following  journal  entry: 

Office  Equipment      ....       $600.00 

Brown  Furniture  Company  ....  $600.00 

In  case  of  a  sale  of  property  on  account,  the  reverse  entry  is  made  in 
the  journal,  the  account  of  the  customer  being  debited  and  the 


150  PRINCIPLES  OF  ACCOUNTING 

property  account  being  credited.  As  explained  in  the  discussion  of 
the  fixed  assets  accounts,  the  latter  transaction  may  also  involve  an 
entry  to  the  reserve  for  depreciation  account  (see  chapter  vi). 

It  has  been  explained  in  chapter  xii  that  when  goods  are  sold  on 
account  a  record  of  the  transaction  is  made  in  the  sales  journal,  and 
that  when  cash  is  received  in  payment  a  record  of  the  cash  received  is 
made  on  the  debit  side  of  the  cash  book.  However,  written  promises 
or  notes  are  sometimes  received  in  payment  of  merchandise  sold, 
the  note  being  given  at  the  time  of  the  sale  or  later  in  payment  of  the 
oral  promise  previously  given.  In  either  case,  it  is  customary  to 
record  the  sale  of  the  merchandise  as  an  account  sale  in  the  sales 
journal  and  record  the  receipt  of  the 'note  in  payment  separately  in 
the  journal.  If  the  student  will  follow  through  a  transaction  of  this 
kind  he  will  readily  see  the  effect  of  this  procedure.  If  James  King 
purchases  $200  of  merchandise  on  account,  there  would  be  an  entry 
or  entrie's  in  the  sales  journal  by  which  King's  account  would  be 
debited  and  the  sales  'account  credited  for  $200.  If  he  sends  his 
thirty-day  note  at  the  end  of  the  month  in  payment  of  the  account, 
an  entry  would  be  made  in  the  journal  as  follows: 

Notes  Receivable      .       .       .       .       $200.00 

James  King 8200.00 

The  effect  of  this  entry  is  to  cancel  the  charge  made  to  the  account  of 
James  King  at  the  time  of  the  sale,  and  to  show  the  claim  of  the 
business  against  James  King  in  the  form  of  a  written  claim  as  reflected 
in  the  notes  receivable  account,  instead  of  showing  it  as  an  oral  claim. 
When  notes  are  used  by  the  business  in  payment  of  merchandise 
bought,  a  similar  procedure  is  followed.  The  purchase  is  recorded 
hi  the  purchases  journal  as  a  debit  to  the  purchases  account  and  a 
credit  to  the  account  of  the  creditor.  When  the  note  is  issued  hi 
payment,  whether  immediately  or  at  some  future  time,  a  journal 
entry  is  made  debiting  the  creditor's  account  and  crediting  the  notes 
payable  account.  This  changes  the  form  of  the  obligation  of  the 
business  to  the  creditor  from  an  oral  to  a  written  promise.  Occa- 
sionally errors  are  made  in  recording  transactions,  and  these  errors 
result  in  incorrect  amounts  being  debited  and  credited  to  the  accounts, 
or  in  debits  and  credits  being  made  to  wrong  accounts.  These 
errors  may  be  discovered  later  in  the  fiscal  period  and  frequently  the 


THE  USE  OF  THE  GENERAL  JOURNAL  151 

easiest  method  of  correcting  them  is  by  means  of  a  new  journal 
entry.  For  instance,  there  may  have  been  an  expenditure  of  $200 
which  should  have  been  charged  to  administrative  expense,  but  the 
bookkeeper  carelessly  recorded  it  as  a  debit  to  selling  expense  and 
posted  it  accordingly.  The  owner  in  looking  over  the  trial  balance 
notices  that  the  selling  expense  for  the  month  is  larger  than  usual 
and  very  naturally  seeks  the  cause.  He  may  notice  that  the  admin- 
istrative expense  is  smaller  than  for  the  previous  month  and  this  may 
suggest  to  him  that  an  error  has  been  made.  In  any  case  the  book- 
keeper, in  seeking  an  explanation  of  the  variation  of  the  selling  ex- 
penses, will  take  the  items  in  the  selling  expense  account  and  trace 
them  through  the  paging  given  in  the  folio  column  back  to  the  book 
of  original  entry  whence  they  came.  By  looking  at  the  explanations 
recorded  in  the  books  of  original  entry  he  will  seek  to  find  any  item 
which  has  been  improperly  charged.  If  by  this  means  he  located  the 
entry  by  which  the  $200  is  improperly  charged  to  selling  expenses, 
he  must  by  some  means  correct  the  error.  As  they  stand,  the  admin- 
istrative expenses  are  $200  too  small  and  the  selling  expenses  are  $200 
too  large.  The  easiest  method  of  correcting  the  error  is  to  make  a 
journal  entry  as  follows: 

Administrative  Expenses.        .        .       $200.00 

Selling  Expenses $200.00 

To  correct  error  made  by 
charging  through  the  cash 
book  on  June  16  $200  to  sell- 
ing expenses  which  should 
have  been  charged  to  admin- 
istrative expenses. 

In  the  case  of  a  correcting  entry  such  as  the  above,  a  very  complete 
explanation  must  be  given  so  that  the  reason  for  the  entry  can  be 
readily  determined  if  the  matter  again  arises. 

Correcting  entries  of  various  kinds  will  also  be  required  during  the 
fiscal  period  in  a  business  which  performs  numerous  and  varied  trans- 
actions. The  correcting  entry  just  shown  serves  only  as  an 
illustration  of  one  type,  but  from  it  the  student  should  be  able  to 
understand  the  nature  of  such  entries.  In  the  laboratory  exercises 
given  at  the  end  of  the  various  chapters  he  will  find  illustrations  of 
other  correcting  entries. 


152  PRINCIPLES  OF  ACCOUNTING 

Although  it  is  impossible  to  give  an  inclusive  discussion  of  the 
transactions  which  may  be  recorded  in  the  general  journal  during  the 
course  of  the  fiscal  period,  the  following  list  gives  the  more  common 
ones.  These  entries  may  be  included  under  the  heading  of  "  current 
entries,"  since  they  are  all  made  from  time  to  time  during  the  period, 
rather  than  at  its  end. 

1.  Purchases  on  account  of  services  and  of  property  other  than 
merchandise, 

2.  Sales  on  account  of  property  other  than  merchandise. 

3.  Receipt  of  property  other  than  cash  in  payment  of  obligations 
due  the  business. 

4.  Issuance  of  property  other  than  cash  in  payment  of  obligations 
owned  by  the  business. 

5.  Corrections  of  entries  which  have  been  incorrectly  recorded 
or  which  have  been  wholly  or  in  part  canceled. 

Adjusting  entries.  In  the  discussion  of  the  periodic  summary  of 
the  ledger  (chapter  ix)  it  was  explained  that  at  the  end  of  the  fiscal 
period  certain  entries  are  necessary  in  order  to  adjust  some  of  the 
accounts  so  that  they  will  reflect  correctly  the  financial  condition  of 
the  business.  These  entries  as  explained  in  the  previous  discussion 
are  known  as  adjusting  entries.  The  student  should  not  confuse 
these  entries  with  those  discussed  under  the  head  of  correcting  entries 
in  the  preceding  paragraph.  Correcting  entries  are  made  during  the 
fiscal  period  to  correct  an  erroneous  entry  or  to  record  the  partial  or 
complete  cancellation  of  a  transaction.  Adjusting  entries  are  made 
at  the  end  of  the  fiscal  period  to  adjust  the  value  of  accounts  which 
reflected  accurately  the  financial  condition  of  the  business  at  the 
beginning  of  the  period  or  at  the  time  of  their  construction,  but  which 
have  changed  in  value  since  that  time. 

In  chapter  ix  it  was  explained  that,  in  connection  with  the 
accounts  of  W.  A.  Williams,  the  following  adjustments  were  necessary: 
The  inventory  account  must  be  adjusted  so  as  to  show  the  disposition 
of  the  beginning  inventory  of  $2,500  and  the  possession  of  an  ending 
inyentory  of  $3,500;  and  this  was  accomplished  by  a  debit  to  the 
purchases  account  and  a  credit  to  the  inventory  account  for  the  old 
inventory  and  a  debit  to  the  inventory  account  and  a  credit  to  the 
purchases  account  for  the  new  inventory;  there  was  an  estimated 
depreciation  of  $50  on  office  furniture  and  of  $200  on  the  building,  and 
this  depreciation  must  be  recorded  by  a  debit  to  administrative 


THE  USE  OF  THE  GENERAL  JOURNAL 


153 


expense  and  a  credit  to  a  reserve  for  depreciation  of  office  furniture 
and  to  a  reserve  for  depreciation  of  building. 

The  entries  of  these  adjustments  were  made  (see  pages  109, 112, 113) 
directly  in  the  accounts,  since  the  purpose  of  the  discussion  at  that  time 
was  to  show  the  effect  of  business  operations  on  the  ledger  accounts. 
Books  of  original  entry  had  not  been  introduced.  In  subsequent 
chapters,  however,  the  use  of  books  of  original  entry  was  explained. 
The  advantage  of  having  all  transactions  recorded  in  some  book  of 
original  entry  prior  to  their  entry  in  the  accounts  has  been  seen. 
To  secure  this  advantage,  adjusting  and  closing  entries  should  be 
recorded  hi  the  journal,  and  from  there  posted  to  their  respective 
accounts.  The  chief  advantage  of  this  method  is  that  all  entries  in 
the  ledger  can  be  traced  back  to  their  original  source  and  an  expla- 
nation therefor  obtained.  It  also  minimizes  error  and  greatly  facili- 
tates the  finding  of  any  errors  which  may  occur. 

The  adjusting  entries  required  in  connection  with  the  accounts  of 
W.  A.  Williams  given  hi  chapter  ix  in  journal  form  will  be  as  follows: 


3i 
Purchases 
Inventory 
To  transfer  the  inventory  of  Janu- 
ary i,  iQiS,  to  purchases 

2,500 

00 

2,500 

00 

Inventory 
Purchases 
To  record  the  inventory  of  Decem- 
ber 31,  1918 

3,5oo 

00 

3,500 

00 

Administrative  expenses 
Reserve   for   depreciation   of   office 
furniture 
To  record  the  estimated  deprecia- 
tion on  office  furniture 

So 

oo 

50 

00 

Administrative  expenses 
Reserve  for  depreciation  of  building 
To  record  the  estimated  deprecia- 
tion on  building 

200 

00 

2OO 

00 

When  these  entries  are  posted,  the  accounts  will  show  the  same  results 
,  as  they  do  hi  the  illustrations  given  in  chapter  ix. 

The  closing  entries.  In  chapter  ix  it  was  explained  that  there  are 
certain  entries  necessary  at  the  end  of  the  fiscal  period  in  order  to 
summarize  the  results  of  the  period  and  make  the  income  and  expense 
accounts  on  the  ledger  correspond  to  the  summary  shown  on  the 


154 


PRINCIPLES  OF  ACCOUNTING 


statement  of  profit  and  loss.  In  that  chapter  it  was  also  explained 
that  the  closing  of  the  Imaginary  ledger  of  W.  A.  Williams  would 
involve  the  following:  the  transfer  of  the  balance  of  the  purchases 
account  to  the  debit  of  the  sales  account ;  the  transfer  of  the  balance 
of  the  sales  account  to  the  credit  of  the  profit  and  loss  account;  the 
transfer  of  the  balances  of  the  selling  expense  and  administrative 
expense,  buying  expense,  and  delivery  expense  accounts  to  the  debit 
of  the  profit  and  loss  account;  and  the  transfer  of  the  balance  of  the 
profit  and  loss  account  to  the  credit  of  the  proprietor's  account. 

For  the  same  reasons  given  in  the  case  of  adjusting  entries,  the 
closing  entries  should  be  recorded  in  the  journal  and  posted  from 
there  to  the  ledger  accounts.  The  journal  entries'  for  closing  the 
ledger  of  W.  A.  Williams  are  as  follows: 


Sales 
Purchases 
To  transfer  cost  of  goods  sold  to  the 
sales  account 

24,000 

oo 

24,000 

oo 

Sales 
Profit  and  Loss 
To  transfer  gross  profit  on  sales  to 
the  profit  and  loss  account 

7,000 

00 

7,000 

00 

Profit  and  Loss 
Buying  Expenses 
To  transfer  buying  expenses  to  the 
profit  and  loss  account 

444 

00 

444 

00 

Profit  and  Loss 
Selling  Expenses 
To    transfer    selling    expenses    to 
profit  and  loss  account 

1,440 

00 

1,440 

00 

Profit  and  Loss 
Delivery  Expenses 
To  transfer  delivery  expenses  to 
profit  and  loss  account 

7SO 

00 

75° 

oc 

s 

Profit  and  Loss 
Administrative  Expenses 
To  transfer  administrative  expenses 
to  profit  and  loss  account 

3,366 

oo 

3,366 

oo 

Profit  and  Loss 
W.  A.  Williams 
To  transfer  net  profit  for  the  fiscal 
period  to  the  proprietor's  account 

1,000 

oo 

1,000 

00 

THE  USE  OF  THE  GENERAL  JOURNAL  155 

When  the  entries  on  page  154  are  posted,  the  accounts  will  show  the 
same  results  that  they  do  in  chapter  ix,  where  the  entries  are  made 
directly  in  the  accounts. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  A.  M.  Jones  has  been  recording  all  the  transactions  of  his  business  in  a 
journal.     His  business  has  increased  until  he  thinks  it  desirable  to  use 
a  purchases  journal,  a  sales  journal,  and  a  cash  book.     He  is  in  doubt 
whether  he  should  retain  the  general  journal  and,  if  so,  what  entries 
should  be  made  in  it.    What  advice  should  you  give  him  ?    Why  ? 

2.  J.  A.  Hoffer  opens  a  retail  store  on  January  i,  1920,  when  his  assets 
and  liabilities  are  as  follows: 

Cash $    500.00 

Merchandise  inventory 2,200.00 

Office  furniture 300.00 

Building 2,000.00 

Land 1,000.00 

Notes  payable 1,500.00 

Accounts  payable 500.00 

Explain  the  opening  entry  necessary  to  record  Hoffer's  investment. 

3.  Mr.  Hoffer  purchases  on  account  delivery  equipment  to  the  value  of 
$300.00.     Explain  the  entries  necessary  to  record  this  transaction. 

4.  Later,  Mr.  Hoffer  has  old  delivery  equipment  for  which  he  originally 
paid  $200.00.    He  sells  this  for  $25.00.     State  what  entries  should  be 
made  at  the  time  of  sale. 

5.  Mr.  Hoffer  gives  the  King  Mercantile  Company  a  note  for  $300.00  to 
apply  on  account.    Explain  how  this  transaction  would  be  recorded. 

6.  The  bookkeeper  of  the  X.  Y.  Company  has  charged  $100.00  to  delivery 
expenses  that  should  have  been  charged  to  administrative  expenses. 
Explain  how  this  error  should  be  corrected. 

7.  On  January  i,  1917,  A.  R.  King  has  an  inventory  of  $3,000.00.    On 
December  31,  1917,  he  has  an  inventory  of  $4,000.00.     Explain  the 
entries  necessary  to  show  the  disposition  of  the  old  inventory  and  the 
possession  of  the  new  inventory     State  where  these  entries  would  be 
made. 

8.  On  December  31,  1917,  King  desires  to  show  a  summary  of  his  year's 
operations  on  his  ledger.    On  his  ledger  he  maintains  the  following 
income  and  expense  accounts: 

Purchases  account 

Sales  account 

Selling  expense  account 


156 


PRINCIPLES  OF  ACCOUNTING 


Buying  expense  account 

Delivery  expense  account 

Administrative  expense  account 

Profit  and  loss  account 

Proprietor's  account 

Briefly  explain  how  a  summary  of  his  ledger  would  be  made.    Where 
would  the  necessary  entries  be  made  in  his  record  ?    What  are  such 
entries  called  ? 
9.  A.  R.  King  has  these  entries  recorded  in  his  journal: 


Jan.  i 

Cash                                                          t           500 

oo 

Merchandise  Inventory                                 2,000 

oo 

Building                                                         3,ooo 

00 

Land                                                               i  ,500 

oo 

Notes  Payable 

1,000 

00 

Accounts  Payable 

1,500 

00 

A.  R.  King,  Proprietor 

4,500 

oo 

Jan.  5 

Office  Equipment                                             300 

oo 

Chicago  Furniture  Co. 

300 

00 

Jan.  10 

. 

Notes  Receivable                                               80 

oo 

William  James 

80 

00 

Jan.  1  6 

James  Randolph                                               100 

00 

Office  Furniture 

100 

00 

Dec.  i 

H.  R.  Johnson                                                  150 

00 

Notes  Payable 

150 

00 

Dec.  15 

Selling  Expenses                                                 46 

00 

Administrative  Expenses 

46 

00 

Dec.  31 

Selling  Expenses                                                 85 

oo 

Reserve  for  Bad  Debts 

85 

00 

Dec.  31 

Sales                                                               3,000 

oo 

Purchases 

3,000 

00 

Dec.  31 

Profit  and  Loss                                                1,200 

00 

Administrative  Expenses 

1,200 

00 

Explain  the  purpose  of  each  of  the  entries  above  and  state  whether  it 
would  be  termed  an  opening,  correcting,  adjusting,  or  closing  entry. 

REFERENCES  FOR  FURTHER  STUDY 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xxii. 


THE  USE  OF  THE  GENERAL  JOURNAL  157 

LABORATORY  EXERCISE  NO.  31 

Record  the  following  transactions,  using  the  sales  book,  purchases  book, 
cash  book,  and  journal.  Illustrations  of  these  are  given  in  chapters  xi 
and  xii. 

March  i.  R.  E.  Taylor  invests  $10,000.00  in  the  wholesale  business 
at  200  South  State  St. 

2.  Rents  store  and  warehouse  for  one  year  at  a  monthly  rental 
of  $150.00,  giving  his  check  for  that  amount. 

Purchases  from  A.  R.  Miller  on  thirty-day  account,  mer- 
chandise, $400.00. 

3.  Paid  Blattner  Bros,  for  office  furniture,  $225.00. 

4.  Purchases    of    Ralph    McCoy    on    twenty-day    account, 
merchandise,  $350.00. 

5.  Purchases    from    A.    P.    Copeland,    thirty-day    account, 
merchandise,  $40.00. 

6.  Sells  A.  K.  Davies,  ninety-day  account,  merchandise,  $92.50. 

7.  Purchases  of  A.  R.  Miller,  thirty-day  account,  merchandise, 
$250.00. 

8.  Pays  for  postage  and  stationery,  $7.80. 

9.  Pays  Harry  James,  bookkeeper,  $15.00,  and  David  Swanson, 
salesclerk,  $12.00. 

10.  Purchases  as  follows: 

F.  M.  Jones,  ten-day  account,  merchandise,  $180.00. 

A.  P.   Copeland,   twenty-day    account,  merchandise, 

$150.00. 

Carl  Hamlet,  ten-day  account,  merchandise,  $120.00. 
it.  Sells  as  follows: 

A.  L.  Anderson,  ten-day  account,  merchandise,  $250.00. 

M.   M.   McGee,    twenty-day    account,    merchandise, 

$300.00. 

12.  R.  E.  Taylor  withdraws  for  personal  use,  $60.00. 

13.  Buys  of  J.  H.  Holliday  and  Company  for  cash,  office  fur- 
niture, $110.00. 

14.  Buys  of  H.  H.  Smith  Typewriter  Company  for  cash,  one 
typewriter,  $100.00. 

15.  Sells  as  follows: 

E.  R.  Mears,  cash,  $75.00. 

L.  O.  Lay,  thirty-day  account,  merchandise,  $280.00. 

16.  Pays  clerk  hire  as  follows: 

Harry  James,  $15.00. 

David  Swanson,  $12.00. 

Received  of  A.  K.  Davies  payment  of  invoice  of  March  6, 
$92.50. 


15$  PRINCIPLES  OF  ACCOUNTING 

17.  Sells  as  follows: 

G.  B.  Crawford,  merchandise,  $975.00. 

E.  B.  Case,  merchandise,  $275.00. 

18.  Purchases  as  follows? 

Ralph  McCoy,  n/2o,  merchandise,  $650.00. 

F.  M.  Jones,  n/2O,  merchandise,  $340.00. 
W.  T.  Dickens,  n/io,  merchandise,  $700.00. 

19.  R.  E.  Taylor  has  sent  to  his  home  for  private  use  merchandise 
to  the  value  of  $15.00. 

NOTE. — This  exercise  is  continued  at  the  end  of  the  next  chapter. 


CHAPTER  XIV 

BUSINESS  VOUCHERS  AND  FORMS 

Purpose  of  the  voucher. — The  student  now  has  an  understanding 
of  the  nature  and  purpose  of  the  accounting  reports.  The  use  of  the 
ledger  accounts  in  classifying  the  information  needed  for  making  such 
reports  has  also  been  explained,  as  well  as  the  use  of  the  books  of 
original  entry  as  a  convenient  means  of  analyzing  each  business 
transaction,  and  as  a  basis  for  posting  to  the  ledger  accounts. 

It  is  scarcely  to  be  thought,  however,  that  a  correct  record  can  be 
kept  hi  the  books  of  original  entry  of  all  the  transactions  that  take 
place  in  the  business  without  some  sort  of  written  memoranda  of  such 
transactions  being  transmitted  to  the  bookkeeper.  Without  such 
memoranda  he  cannot  possibly  know  all  the  happenings  of  the 
business  which  affect  the  accounts.  This  is  well  illustrated  by  the 
case  of  a  large  department  store,  whose  sales  clerks  are  making 
hundreds  of  sales  each  day,  while  its  buyers  are  purchasing  goods  and 
letting  contracts  for  the  different  departments  in  the  various  source 
markets.  Clearly  enough,  in  any  modern  business  establishment 
larger  than  a  small  one-room  shop,  there  must  be  some  regular  pro- 
vision for  notifying  the  accounting  department  of  each  transaction 
that  takes  place  in  the  business.  Even  if  the  person  who  performs 
the  transaction  is  also  the  one  who  enters  it  in  the  books,  some  memo- 
randum should  be  made  of  it,  since  otherwise  the  details  may  be  for- 
gotten before  the  record  can  be  made.  It  will  be  found,  therefore, 
that  almost  every  business  concern  uses  certain  forms  for  making  a 
notation  of  the  essentials  of  each  business  transaction  at  the  time  it  is 
performed.  Such  forms  are  known  as  vouchers.  A  voucher,  in  this 
use  of  the  word,  may  be  denned  as  the  written  evidence  of  a  business 
transaction. 

It  will  be  found  that  there  are  vouchers  which  serve  not  only  as  a 
basis  for  recording  the  transactions  out  of  which  they  rise  but  also 
as  a  means  of  facilitating  these  transactions.  Indeed,  some  of  the 
vouchers  which  will  be  discussed  in  the  following  pages  are  not  used  as 


160  PRINCIPLES  OF  ACCOUNTING 

a  basis  for  making  entries,  but  only  for  the  facilitation  of  the  operation. 
These  will  be  discussed  along  with  the  others,  but  it  is  in  the  use  of  the 
voucher  as  the  primary  evidence  of  the  transaction  that  we  are  at 
present  primarily  interested. 

Classification  of  vouchers  and  forms.  Owing  to  the  variations  in 
systems  of  accounting  used  by  different  businesses,  there  is  even  a 
greater  number  of  kinds  of  vouchers  than  of  books  of  original  entry. 
It  is  evident  that  all  these  forms  cannot  be  considered  here.  Not 
even  an  inclusive  classification  will  be  made  at  this  point.  A  simple 
classification  which  will  serve  well  enough  for  purposes  of  the  present 
discussion  is  as  follows:  (i)  vouchers  used  in  connection  with  the 
purchase  and  sale  of  merchandise;  (2)  negotiable  vouchers;  (3)  mis- 
cellaneous vouchers  and  forms  not  included  in  either  of  the  first  two 
classes. 

The  merchandise  invoice.  When  a  sale  of  goods  is  made,  it  is 
customary  for  the  seller  to  make  out  a  statement  of  essential  facts, 
a  copy  of  which  he  sends  to  the  buyer.  Such  a  statement  is  known  to 
both  buyer  and  seller  as  an  invoice.  To  the  buyer  it  is  a  purchases 
invoice,  while  to  the  seller  it  is  a  sales  invoice.  It  is  an  itemized  state- 
ment from  the  seller  to  the  buyer  of  the  goods  sold,  together  with  the 
prices  and  the  total  amount  of  the  sale.  Other  items  of  information 
ordinarily  shown  are  the  name  and  address  of  both  buyer  and  seller, 
the  date  of  sale,  the  terms  of  sale,  the  method  of  shipment  or  delivery, 
and  the  serial  number  of  the  sales  invoice.  Any  other  desired  infor- 
mation, such  as  the  number  of  the  salesman  making  the  sale,  and  the 
department  from  which  the  goods  is  sold,  may  also  be  shown.  The 
method  employed  in  making  use  of  the  invoice  for  purposes  of 
the  purchase  or  sales  record  will  be  discussed  briefly  below. 

When  goods  are  purchased  by  a  business  concern,  the  invoice 
for  the  goods  usually  arrives  before  the  goods  themselves.  If  so,  it  is 
placed  in  a  temporary  file  until  the  arrival  of  the  goods.  As  soon  as 
the  latter  are  received,  they  are  checked  with  the  invoice  to  see  that 
they  correspond  to  the  goods  listed  on  the  invoice  in  quantity,  kind, 
and  price,  and  the  extensions  and  total  are  verified.  If  everything  is 
found  to  be  correct  and  in  order,  the  invoice  is  then  used  as  the  basis 
for  an  entry  in  the  purchases  journal,  as  described  in  a  previous 
chapter.  Each  purchases  invoice  when  received  is  given  its  serial 
number  in  the  purchaser's  records,  and  this  number  is  entered  in  the 


BUSINESS  VOUCHERS  AND  FORMS  161 

appropriate  column  in  the  purchases  journal.  After  being  entered, 
the  invoice  is  filed.  If  it  represents  a  credit  purchase,  it  is  filed  in  a 
"tickler  file"  of  unpaid  invoices,  under  the  date  upon  which  it  should 
be  paid.  When  it  has  been  paid  and  the  payment  recorded  properly 
in  the  cash  book,  it  is  placed  in  a  permanent  file,  according  to  some 
appropriate  system  of  filing.  It  is  there  available  for  future  reference 
in  case  need  should  arise. 

The  routines  followed  in  handling  the  sales  invoice,  or  the  "  sales 
ticket,"  as  it  is  usually  termed  hi  retail  establishments,  are  by  no 
means  identical.  In  a  wholesale  business,  one  or  more  copies  of  the 
invoice  are  generally  retained  by  the  selling  organization.  One  of 
these  is  sent  to  the  accounting  department,  where  it  serves  as  a  basis 
of  entering  the  transaction  in  the  sales  journal.  When  remittance 
is  received  from  the  customer,  the  check  may  pass  through  the 
accounting  department,  thus  serving  as  a  basis  for  the  entry  in  the 
cash  book  to  show  the  payment  of  the  invoice,  or  a  special  form  may  be 
used  to  notify  this  department  of  the  payment.  Sometimes  a  copy 
of  the  invoice  itself,  stamped  "Paid"  is  sent  to  the  accounting  depart- 
ment for  this  purpose.  The  entry  in  all  of  these  cases  is  the  same. 
A  copy  of  the  invoice  may  also  be  kept  hi  the  files  of  the  credit  depart- 
ment until  it  is  paid.  After  payment,  this  or  some  other  copy  is 
filed  in  a  permanent  file,  where  it  may  be  located  by  means  of  its 
serial  number  in  case  any  reference  to  it  is  desired. 

In  a  retail  business  the  cash  sales  are  generally  of  much  greater 
importance,  relatively,  than  they  are  hi  a  wholesale  business.  The 
duplicate  sales  tickets  for  the  cash  sales  in  each  department  are 
totaled  at  the  end  of  the  day's  business,  these  totals  being  checked 
against  the  total  of  cash  received  from  that  source,  and  then  entered 
in  the  proper  records  as  totals.  The  credit  sales  are  sometimes 
entered  item  by  item  in  the  sales  journal  and  the  posting  to  the 
customers'  accounts  done  from  that  record,  but  hi  the  larger  retail 
concerns  it  is  usual  for  them  to  be  entered  by  totals,  and  for  the  post- 
ing to  the  customers'  accounts  to  be  made  directly  from  the  sales 
tickets.  In  some  retail  stores  no  posting  is  done  to  the  accounts  with 
customers.  Instead,  the  credit  sales  are  entered  by  totals,  and  the 
duplicate  sales  tickets  filed  under  the  name  of  the  customer.  When 
a  remittance  is  received  from  the  customer,  the  proper  entry  is  made 
in  the  cash  book,  and  the  tickets  covered  by  the  remittances  are 


162 


PRINCIPLES  OF  ACCOUNTING 


either  sent  to  the  customer  or  destroyed.  The  amount  owed  to  the 
business  by  a  customer  at  any  time  is  shown  by  the  total  of  the 
tickets  filed  under  his  name.  These  tickets  serve  as  the  basis  of 
the  monthly  statement  of  account  to  be  sent  to  the  customer,  if  it  is 
the  practice  of  the  business  to  send  out  such  statements. 

Form  of  the  merchandise  invoice.  The  form  of  the  invoices  used 
by  different  businesses  varies  considerably  in  detail,  as  suggested 
in  the  foregoing  discussion.  The  following  form,  however,  may  be 
considered  typical  of  the  sales  invoices  sent  by  wholesale  businesses 
to  their  customers. 


MAJ 
to, 

Sol 
On 

RSHALL-WELLS  HARDWARE  COMPANY 
5  Marquette  Ave.,  MINNEAPOLIS,  MIXN.             T< 
WHOLESALE  HARDWARE 

rl  ta                                                                                              Terms 

:lephone: 
Central  450 

:  Sixty  Days. 
within   ten 
>m  date,  2  per 
lay    be    de- 
terms     and 
ms  shown  on 
side. 

If  paic 
days  f  re 

ler  No. 

ducted. 
Other 
conditk 
reverse 

4 

In  referring  to  this  invoice,  please  give  date  and  number.     If  any  of  these 
goods  are  unsatisfactory,  complaint  should  be  made  within  five  days  of  their 
receipt.    They  are  not  returnable  without  our  permission. 

On  page  163  is  shown  a  form  of  the  sales  ticket  which  is  given  to 
the  customer  by  a  large  retail  establishment.  It  may  be  considered 
typical  of  the  sales  tickets  used  hi  retail  businesses. 

Negotiable  instruments.  In  earlier  chapters  it  was  pointed  out 
that  business  consists  of  a  series  of  operations,  each  of  which  involves 


BUSINESS  VOUCHERS  AND  FORMS 


163 


Order  No. 
or  Buyer 

Date 

Customer's  Memorandum 

Salesperson's 
No 

Delivered  by 
Floorman 

THAT!  OF.         .   .  . 

This  memorandum  should  be  kept  to  check  monthly  bill,  except 
when  merchandise  is  returned,  when  it  should  be  sent  back  with 
goods,  in  order  that  the  proper  credit  be  made. 
Merchandise  to  be  credited  on  current  bill  must  be  returned  before 
the  last  day  of  the  month. 

THE  CHICAGO  STORE 
CHICAGO 

207                                                                           25 

an  exchange  of  values.  Such  exchanges  of  values  are  assisted  greatly 
by  the  use  of  negotiable  instruments.  It  has  been  explained  that  cus- 
tomers often  paid  for  merchandise  by  means  of  checks.  This  means 
that  the  customer  has  hi  some  manner  established  a  credit  to  his 
account  at  a  bank,  and  that  he  writes  an  order  to  the  bank  to  pay  a 
certain  amount  to  the  order  of  his  creditor,  the  acceptance  of  this 
order  by  the  creditor  serving  to  discharge  the  obligation.  The 
method  by  which  credit  may  be  established  at  the  bank  will  be  dis- 
cussed in  chapter  xv.  For  the  present  it  is  sufficient  to  point  out 
that  the  usual  method  by  which  "cash"  payments  are  made  between 
businesses  is  by  the  delivery  to  the  creditor  of  a  check  drawn  by  the 
debtor  against  some  bank  with  which  he  has  a  balance.  The  creditor 
will  then  ordinarily  "indorse"  the  check,  in  a  manner  to  be  explained 


1 64  PRINCIPLES  OF  ACCOUNTING 

later,  and  send  it  to  his  own  bank  to  be  credited  to  his  account  there. 
When  he  does  this  he  is  said  to  deposit  it.  The  bank  with  which  the 
check  is  deposited  then  secures  settlement  on  the  check  from  the  bank 
upon  which  it  is  drawn.  This  may  be  done  by  sending  it  directly 
to  the  other  bank;  by  sending  it  to  the  clearing  house,  the  organization 
through  which  banks  adjust  their  claims  against  each  other;  or  by 
sending  it  to  another  bank  which  will  secure  payment  on  it.  A  form 
of  check  which  shows  the  essentials  of  such  an  instrument  is  given 
below 


Another  possible  method  of  payment  is  that  of  giving  the  creditor 
a  note,  which,  as  already  explained,  is  the  debtor's  written  promise 
to  pay  the  specified  sum  at  a  certain  future  date.  Such  a  note  re- 
ceived from  a  customer  is  a  note  receivable  to  the  business  to  whom  it  is 
payable,  and  a  note  payable  to  the  business  making  the  promise  to  pay. 
The  essentials  of  such  an  instrument,  and  the  form  which  it  ordinarily 
takes,  are  indicated  by  the  following  illustration: 


Out 


at  Us  Banking  House  m  Chicago  Illinois,  with  Interest  AFTER  MATURITY  at  the  rate  of  seven  per  cent  per 
annum  until  paid  and  with  costs  of  collection  and  a  reasonable  attorney  fee  if  not  paid  at  maturity.  Presentment 
and  demand  for  payment,  notice  of  non-payment,  protest  and  notice  of  protest  an  each  and  all  hereby  waived  by 
the  makers,  endorsers  and  guarantors  Jointly  and  severally.  Any  Indebtedness  owing  from  said  bank  or  legal 
holder  hereof  to  the  undersigned  or  to  any  endorser  or  guarantor  may  be  appropriated  and  applied  by  said  bank 
or  legal  holder  on  this  note  at  any  time  either  before  or  after  maturity  of  this  note  and  without  demand  upon  or 
notice  to  any  one. 


BUSINESS  VOUCHERS  AND  FORMS  165 

In  the  foregoing  discussion  of  the  use  of  the  note,  it  was  referred 
to  as  settling  the  obligation.  But  it  is  readily  seen  that  it  does  this 
only  in  the  sense  that  one  form  of  obligation  is  settled  by  creating  a 
different  form.  When  the  time  for  which  the  note  is  drawn  has 
elapsed,  payment  must  be  made  on  the  note  itself.  This  is  usually 
done  by  means  of  a  check.  If  goods  are  purchased  on  open  account, 
payment  may  be  made  by  check,  or  a  note  may  be  given  to  discharge 
the  obligation  on  open  account,  and  the  note  paid  at  maturity  by 
check,  thus  involving  both  forms  discussed  above.  A  firm  unable 
to  meet  its  open  accounts  at  the  time  when  they  are  due  will  some- 
times secure  an  extension  by  giving  a  note  for  the  amount,  payable 
at  a  later  time.  This  does  not  represent  a  desirable  situation. 

The  processes  described  above  are  the  same,  whether  looked  at 
from  the  point  of  view  of  the  selling  concern  or  from  that  of  the  one 
doing  the  purchasing.  They  will,  of  course,  be  recorded  differently 
on  the  books  of  the  two.  The  note  and  check  are  used  not  only  in  the 
purchase  of  merchandise  but  also  in  payment  for  other  assets,  current 
and  fixed,  and  for  services.  In  the  purchase  of  fixed  assets,  such  as 
land  and  buildings,  notes  may  be  given  which  have  a  more  distant 
maturity.  Sometimes  they  run  for  several  years.  Such  notes  are 
usually  secured  by  a  mortgage  on  the  property.  The  nature  of  such 
long-time  liabilities  and  their  treatment  in  the  accounts  will  be  con- 
sidered in  a  later  chapter.  The  point  of  the  present  discussion  is 
that  the  note  may  be  used  in  facilitating  practically  any  sort  of 
transaction. 

It  should  be  apparent  that  notes,  checks,  and  instruments  of  similar 
legal  import  have  a  very  important  part  to  play  in  business  trans- 
actions. Since  this  is  true,  the  accountant,  dealing  with  them  almost 
continually,  should  have  some  idea  of  their  nature  and  of  their  peculiar 
legal  aspects,  so  that  he  may  record  properly  the  transactions  involving 
their  use.  This  class  of  business  papers,  serving  as  they  do  to  facilitate 
exchange,  are  known  as  negotiable  instruments,  and  their  importance 
has  led  to  the  attaching  of  certain  definite  legal  consequences  to 
their  use. 

Requisites  of  negotiable  instruments.  The  important  part  played 
by  negotiable  instruments  in  business  has  made  it  desirable  that  there 
should  be  some  very  definite  formulation  of  the  rules  for  their  form  and 
use,  which  should  apply  generally,  and  not  vary  from  state  to  state. 


166  PRINCIPLES  OF  ACCOUNTING 

This  need  has  led  to  the  adoption  in  a  number  of  states,  of  the  Uni- 
form Negotiable  Instruments  Law,  the  purpose  of  which  is  to  formu- 
late the  generally  accepted  usages  and  rulings  with  regard  to  negotiable 
instruments,  and  to  make  such  law  apply  uniformly  in  the  various 
states.  This  law  states  certain  requisites  of  a  negotiable  instrument, 
and  these  are  summarized  below. 

1.  The  instrument  must  be  in  writing  and  signed  by  the  maker  or 
drawer. 

2.  It  must  contain  an  unconditional  promise  to  pay  a  fixed  sum  of 
money. 

3.  It  must  be  payable  on  demand  or  at  a  time  which  is  either 
fixed  or  determinable. 

4.  It  must  be  payable  to  bearer  or  to  order. 

Kinds  of  negotiable  instruments.  There  is  no  particular  specified 
form  which  must  be  followed  in  order  to  give  any  particular  instrument 
these  requisites.  Any  written  instrument  which  possesses  the  essen- 
tials will  be  held  by  a  court  to  be  a  negotiable  instrument.  The 
forms  employed,  however,  have  become  more  or  less  standardized 
through  general  usage,  and  the  standard  form  should  be  used  without 
any  considerable  variation,  in  order  to  avoid  any  possible  difficulty. 
There  are  several  kinds  of  negotiable  instruments,  each  having  a 
somewhat  different  use,  and  each  having  its  peculiar  form.  The 
principal  kinds  may  be  listed  as  follows:  (i)  notes;  (2)  checks; 
(3)  drafts;  (4)  cashier's  checks;  (5)  express  money  orders;  (6)  postal 
money  orders. 

The  draft.  An  example  of  one  form  of  draft,  the  bank  check,  has 
already  been  given.  A  draft  is  a  written  order  from  one  party  to 
another,  directing  this  second  party  to  pay  a  certain  sum  of  money  to  a 
specified  third  party.  The  bank  check  is,  of  course,  such  an  order. 
Owing  to  the  special  nature  of  the  check,  and  the  special  manner  of 
its  use,  it  was  not  discussed  under  the  general  head  of  drafts  but  was 
considered  by  itself.  Drafts  other  than  checks  may  be  classified 
as  (i)  bank  drafts  and  (2)  commercial  drafts. 

A  bank  draft  is  to  all  intents  and  purposes  a  check  drawn  by  one 
bank  on  another.  The  bank  drawing  such  a  draft  generally  has  funds 
on  deposit  with  the  bank  against  which  it  draws,  or  else  some  under- 
standing by  which  it  is  permitted  to  draw  in  advance  of  its  making 
such  deposit.  Bank  drafts  are  used  for  making  payments  at  some 


BUSINESS  VOUCHERS  AND  FORMS  167 

considerable  distance  by  mail.  The  bank  draft  will  circulate  more 
freely  away  from  home  than  will  the  personal  check,  and  the  draft 
does  not  usually  cost  the  recipient  anything  for  collection,  while  the 
check  may.  Thus  if  Mr.  Fred  Dole,  of  Chicago,  has  to  make  a  pay- 
ment to  a  firm  in  Philadelphia,  he  may  go  to  his  bank  in  Chicago  and 
ask  for  a  New  York  draft  in  favor  of  the  Philadelphia  concern.  He 
asks  for  a  New  York  draft,  since  New  York  is  our  financial  center, 
and  banks  in  all  parts  of  the  country  have  connections  with  New  York 
banks.  Mr.  Dole  will  draw  a  Check  payable  to  his  Chicago  bank  for 
the  amount  of  the  draft  he  is  asking  for,  possibly  including  a  small 
charge  for  the  service.  He  will  mail  the  draft  to  the  Philadelphia 
concern,  who  will  probably  deposit  it  at  their  Philadelphia  bank. 
The  latter  bank  will  usually  send  it  to  their  correspondent  bank  in 
New  York  for  credit,  and  this  bank,  if  not  the  one  upon  which  the 
draft  is  drawn,  will  usually  send  it  to  the  bank  upon  which  it  is  drawn 
for  collection.  The  form  of  such  a  draft  may  be  as  follows: 


THE  CORN  EXCHANGE  BANK 

CHICAGO,  ILL.,  May  15,  1920 

PAY  TO  THE  ORDER  OF $800.00 

Eight  Hundred and no/ioo Dollars 

To  THE  NATIONAL  CITY  BANK  .  J.  S.  HARVEY 

NEW  YORK,   N.Y.  Cashier 


The  commercial  draft  is  a  draft  drawn  by  one  private  individual 
or  business  concern  upon  another,  directing  the  second  party  to  pay 
a  certain  sum  of  money  to  a  third  party  named.  Such  a  draft  would 
have  the  following  form: 


$200  DANVILLE,  ILL.,  May  3,  1920 

At  sight  pay  to  the  order  of WILLIAM  JOHNSON 

Two  Hundred and no/ioo Dollars 

Value  received  and  charge  to  the  account  of 

To  CLANAHAN  &  SON  GRANT  BROTHERS 

SPRINGFIELD,  ILL. 


This  is  the  form  of  draft,  or  "bill  of  exchange,"  that  was  used  to  some 
extent  in  the  past,  before  our  present  credit  and  banking  system  was 


1 68  PRINCIPLES  OF  ACCOUNTING 

developed.  The  theory  of  such  a  draft  was  that  Clanahan  and  Son, 
of  Springfield,  were  indebted  to  Grant  Brothers,  of  Danville,  and  the 
latter  owed  William  Johnson,  of  Springfield.  Grant  Brothers,  by 
giving  Johnson  a  draft  against  Clanahan  and  Son,  could  reduce  their 
indebtedness  by  that  amount  without  sending  any  money,  and  Clana- 
han and  Son,  by  accepting  and  paying  the  draft,  could  reduce  their 
indebtedness  to  Grant  Brothers  without  sending  money  to  Danville. 
With  the  modern  system  of  banking,  such  a  procedure  has  become 
archaic,  and  is  of  interest  only  from  a  historian's  point  of  view. 
Such  indebtedness  would  today  be  settled  very  easily  by  mailing  a 
personal  check  or  a  bank  draft.  The  chief  reason  why  such  a  "  three- 
cornered  "  draft  is  impracticable  is  that  it  would  be  only  by  the  rarest 
coincidence  that  the  amount  which  Clanahan  and  Son  owed  Grant 
Brothers  would  correspond  with  the  amount  that  the  latter  owed 
Johnson. 

A  form  of  commercial  draft  which  is  at  present  in  use  is  one  by 
which  one  party  draws  upon  a  second  party,  making  the  draft  payable 
to  the  party  drawing  it.  The  nature  of  such  a  draft  can  be  better 
understood  by  seeing  the  form  of  it,  which  is  as  follows: 


$250  CHICAGO,  ILLINOIS,  May  20,  1920 

At  sight  pay  to  the  order  of 
OURSELVES 

Two  Hundred  Fifty  and  no/ioo Dollars 

Value  received,  and  charge  the  same  to  the  account  of 
To  A.  P.  JENS,  WEST  AND  DENNETT 

CHAMPAIGN,  ILL. 


Such  a  draft  as  this  is  ordinarily  used  for  the  purpose  of  speeding  up 
collections.  The  typical  case  represented  by  this  draft  would  be  that 
Jens  owes  West  and  Dennett,  and  that  they  draw  on  him  in  an  effort 
to  collect  the  amount  of  the  debt.  The  draft  would  ordinarily  be 
given  to  West  and  Dennett's  bank  for  collection.  The  bank,  in  turn, 
jvould  forward  it  to  some  bank  in  Champaign,  which  would  notify  Jens 
of  the  draft.  If  he  pays  it,  the  Champaign  bank  would  either  remit 
to  the  Chicago  bank  or  credit  the  account  of  the  Chicago  bank  for 
the  amount,  and  West  and  Dennett's  account  would  be  credited  by 
the  Chicago  bank,  that  firm  being  notified  of  the  collection. 


BUSINESS  VOUCHKKS  AM)  FORMS  169 

The  same  result  might  have  been  obtained  by  making  the  draft 
payable  to  the  Chicago  bank  instead  of  to  West  and  Dennett,  the 
form  of  the  draft  remaining  otherwise  the  same.  The  procedure 
would  not  be  changed  by  this  variation  in  form. 

Another  possible  classification  of  drafts,  according  to  the  time 
when  they  are  payable,  is  into  (i)  sight  drafts  and  (2)  time  drafts. 
The  forms  given  so  far  have  all  been  sight  drafts.  This  is  indicated 
by  the  fact  that  they  are  worded  "At  sight  pay  to  the  order  of,"  etc., 
which  means  that  they  are  payable  at  the  time  of  their  presentation. 
A  time  draft  is  one  which  is  drawn  payable  a  certain  number  of  days 
after  sight  or  after  date.  In  the  case  of  a  time  draft,  if  the  party  upon 
whom  it  is  drawn  is  willing  to  pay  it  and  intends  to  do  so,  he  indicates 
this  by  accepting  it  at  the  time  it  is  presented  to  him,  and  returning 
it  to  the  party  in  whose  favor  it  is  drawn.  Accepting  a  draft  is 
accomplished  by  the  acceptor  writing  the  word  "Accepted"  across  the 
face  of  the  instrument  and  signing  his  name.  It  then  becomes  his 
written  promise  to  pay,  just  as  though  it  were  his  promissory  note. 
From  that  time  on  it  will  be  treated  as  a  promissory  note  in  the 
records  of  all  parties  concerned.  The  form  of  a  time  draft  differs  in 
no  way  from  the  forms  given,  above,  except  that  instead  of  the  words 

"At  sight"  it  bears  the  words  "At days  sight,"  or  " days 

after  date." 

From  the  illustrations  given,  it  is  apparent  that  there  are  three 
parties  to  a  draft.  The  one  who  gives  the  order  is  known  as  the 
drawer;  the  one  to  whom  the  order  is  addressed,  as  the  drawee;  and  the 
one  to  whom  it  is  made  payable,  as  the  payee.  Where  a  draft  is  made 
payable  to  self,  the  same  party  is  both  drawer  and  payee.  The  one 
who  accepts  the  draft,  usually  the  drawee,  is  also  the  acceptor,  and  an 
accepted  draft  is  usually  referred  to  as  an  acceptance,  A  special 
type  of  draft  known  as  a  trade  acceptance  will  be  discussed  later. 

It  has  already  been  stated  that  the  accepted  draft  is  to  be  treated 
as  a  note.  The  entry  made  to  record  the  receipt  of  such  a  draft 
would,  therefore,  be  a  debit  to  notes  receivable  and  a  credit  to  the 
customer,  while  the  entry  to  record  the  acceptance  of  a  draft  would 
be  a  debit  to  the  creditor  and  a  credit  to  notes  payable. 

The  cashier's  check.  The  cashier's  check  is  a  check  drawn  by  a 
bank  against  itself,  being  signed  by  the  cashier  as  agent  of  the  bank. 
Such  checks  are  used  for  the  payment  of  obligations  of  the  bank  itself, 


170  PRINCIPLES  OF  ACCOUNTING 

and  for  transmitting  the  proceeds  of  collections  made  for  persons  or 
firms  who  do  not  have  accounts  with  the  bank  making  such  collections. 
The  form  of  such  a  check  might  be  as  follows: 


r.iitr xr.n 

/         y 

I'XVTO  TITK  OHDEH  OF (Sst&fi/a^'^ef 


Express  and  postal  money  orders.  Express  and  postal  money  orders 
are  quite  similar,  except  that  the  first  are  issued  by  the  express  com- 
pany and  the  second  by  the  United  States  Post-Office.  Both  these 
forms  of  drafts  are  used  for  transferring  money  safely  from  one  city 
to  another.  In  the  case  of  the  express  money  order,  the  person 
desiring  to  transmit  the  money  pays  the  company  the  amount  that 
he  desires  to  transmit,  plus  the  fee  for  the  service,  and  is  given  an 
order  payable  to  the  party  to  whom  the  money  is  to  be  transmitted. 
This  order  is  sent  to  the  payee,  who  cashes  it  at  the  local  office  of  the 
express  company.  The  form  of  an  express  money  order  is  illustrated 
below: 


EXPRESS  MONEY  ORDER 

WHEN  COUNTERSIGNED  13-478392 

By  Agent  at  Point  of  Issue 

AMERICAN  EXPRESS  COMPANY 
agrees  to  transmit  and 

Pay  to  the  order  of DONALD  F.  TOLLEFSON         $750  no 

the  sum  of Seven  Hundred  Fifty  and  no/ioo Dollars 

Paul  Nelson      Agent 
Issued  at 

St.  Paul,  State  of  Minnesota 
Date    June  5,  1920  RAYMOND  S.  GLEASON 


BUSINESS  VOUCHERS  AND  FORMS  171 

The  postal  money  order  will  be  issued  by  a  postmaster,  upon  the 
sender's  written  application  and  the  payment  of  the  amount  named, 
plus  a  fee  for  the  service.  Postal  money  orders  will  be  honored  by 
any  postmaster  when  the  holder  has  been  satisfactorily  identified. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  The  James  Mercantile  Company  has  five  departments  and  there  are 
ten  sales  clerks  in  each  department.    The    accounting    department 
records  the  sales  of  all  of  the  clerks.    How  does  it  obtain  the  amount 
of  their  sales  ? 

2.  The  James  Mercantile  Company  desires  to  know  the  daily,  weekly, 
and  monthly  sales  of  each  clerk.    How  may  these  statistics  be  obtained  ? 

3.  What  is  a  voucher  ?     Give  two  purposes  which  it  may  serve. 

4.  The  X.  Y.  Manufacturing  Company  has  a  stores  department,  a  pur- 
chasing department,  and  a  receiving  department.    The  stores  depart- 
ment keeps  a  record  of  all  goods  on  hand  and  when  the  quantity  of 
any  article  falls  to  a  certain  limit  notifies  the  purchasing  department, 
which  places  an  order  for  the  goods.    The  goods  are  received  by  the 
receiving  department.    In  case  the  quantity  of  goods  received  does  not 
correspond  with  the  quantity  ordered  or  the  quantity  shown  on  the 
invoice,  how  can  this  be  detected  ? 

5.  What  is  the  difference  between  the  sales  invoice  and  the  sales  ticket  ? 

6.  Explain  how  the  sales  ticket  may  be  used  as  a  means  of  facilitating  the 
recording  of  both  cash  and  credit  sales  in  the  case  of  a  large  department 
store. 

7.  The  Boston  Store  of  Wichita,  Kansas,  owes  Marshall  Field  and  Company, 
of  Chicago,  $800.00  for  merchandise.    Explain  three  ways  by  which 
the  Boston  Store  may  pay  this  amount.    Which  way  will  probably  be 
employed  ? 

8.  A.  M.  Elliott  owes  E.  C.  Cline  $400.00  due  this  day.    Being  unable  to 
pay  the  amount,  Elliott  offers  Cline  a  note  for  thirty  days  in  settlement 
of  the  account  and  Cline  accepts  the  offer.    State  the  contents  of  the 
note  which  Elliott  will  give  Cline. 

9.  Give  the  entry  which  Cline  will  make  when  he  receives  the  note  of 
Elliott. 

10.  What  are  the  distinguishing  features  of 
o)  A  bank  draft  ? 

b)  A  commercial  draft  ? 

c)  A  cashier's  check  ? 

d)  An  express  money  order  ? 

Are  these  different  forms  interchangeable  as  regards  their  use  ? 
Explain. 


IT 2  PRINCIPLES  OF  ACCOUNTING 

REFERENCES  FOR  FURTHER  STUDY 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  xxiii  and 

xxiv. 
MOULTON,  H.  G.,  Financial  Organization  of  Society,  chap.  xii. 

LABORATORY  EXERCISE  NO.  31— Continued 

March  20.  Issues  checks  to  the  following: 

F.  M.  Jones,  $180.00  in  payment  of  invoice  of  March  10. 
Carl  Hamlet,  $i  20.00  in  payment  of  invoice  of  March  10. 
21.  Receives  from  A.   L.   Anderson  $250.00  in  payment  of 
invoice  of  March  n. 

Pays  Missouri  Pacific  Railroad  Company  $60.00  in  pay- 
ment of  freight  on  merchandise  sent  over  their  roads  since 
March  i. 

23.  Pays  hire  of  sales  clerks  as  follows: 

David  Swanson,  $12.00. 

J.  B.  Hall,  $14.00. 

Pays  Harry  James,  bookkeeper,  $15.00. 
Purchases  from  Chicago  Real  Estate  Company  a  lot  and 
building  at  200  South  State  Street,  where  the  business  is 
now  conducted,  for  $5,000.00  cash.  The  building  is  valued 
at  $3,000.00  and  the  lot  at  $2,000.00.  You  are  allowed 
$25.00  for  unexpired  rent.  Give  check  for  the  balance. 

24.  Pays  Ralph  McCoy  $350.00  in  payment  of   invoice  of 
March  4.     Pays  Wabash  Railroad  Company  $60.00  in  pay- 
ment of  freight  on  merchandise  received  over  that  road. 

26.  Sells  as  follows: 

H.  L.  Dickerson,  cash,  merchandise,  $240.00. 
E.  N.  Atkins,  n/io,  merchandise,  $750.00. 
J.  B.  Foreman,  n/i5,  merchandise,  $930.00. 

27.  Mr.  Taylor  gives  $20.00  of  merchandise  to  the  Salvation 
Army. 

28.  Gives  a  thirty-day  note  for  $650.00  to   Ralph   McCoy 
in  payment  of  invoice  of  March  18. 

Pays  W.  T.   Dickens  $700.00  in  payment  of  invoice  of 

March  18. 

Pays  F.  M.  Jones  $340.00  in  payment  of  invoice  of  March  18. 

29.  Purchases  as  follows: 

Charles  A.  Hines,  n/io,  merchandise,  $1,010.00. 
Mandel  Brothers,  n/i$,  merchandise,  $2,210.00. 


BUSINESS  VOUCHERS  AND  FORMS  173 

30.  Pays  A.  B.  Copeland  $150.00  in  payment  of  invoice  of 
March  10. 

Sells  M.  J.  Torr  for  cash,  merchandise,  $500.00. 
Sells  I.  M.  Allen,  n/30,  merchandise,  $1,480.00. 

31.  Receives  twenty-day  note  for  $300.00  from  M.  M.  McGee  in 
payment  of  invoice  of  March  n. 

Pays  petty  expense,  $30.00. 
NOTE. — This  exercise  is  completed  at  the  end  of  the  next  chapter. 


CHAPTER  XV 


Indorsement  of  negotiable  instruments.  Since  the  present  discus- 
sion has  to  do  with  negotiable  instruments,  whose  distinguishing 
characteristic,  as  indicated  by  the  name,  is  their  ability  to  pass  readily 
from  hand  to  hand  and  thereby  serve  to  facilitate  the  transfer,  of 
goods,  some  consideration  of  the  method  by  which  such  instruments 
are  to  be  transferred  is  appropriate.  A  legal  transfer  of  a  negotiable 
instrument  may  be  made  by  means  of  an  indorsement  and  delivery 
of  the  instrument,  or,  in  the  case  of  an  instrument  made  payable  to 
bearer,  by  delivery  alone.  The  indorsement  is  made  by  the  payee  or 
the  holder  of  the  note.  It  transfers  the  legal  title  in  the  instrument 
to  the  one  to  whom  it  is  indorsed  and  delivered.  It  has  also  the  legal 
effect  of  a  guaranty  on  the  part  of  the  indorser  that  the  instrument  is 
genuine  and  valid  and  that  he  has  legal  title  to  it.  The  indorsement 
also  usually  enables  the  subsequent  holder  to  hold  the  indorser  for  the 
payment  of  the  instrument  at  maturity,  hi  case  the  one  primarily 
responsible  for  such  payment  should  default.  In  order  to  so  hold  the 
indorser,  certain  legal  requirements  concerning  notice  must  be  satisfied 
by  the  holder.  It  is  not  possible  to  discuss  here  all  the  legal  questions 
involved  in  the  indorsement  of  negotiable  instruments.  It  is  possible, 
however,  to  point  out  certain  legal  consequences  of  the  more  common 
forms  of  indorsement. 

The  forms  of  indorsement  which  are  generally  used  are  as 
follows: 

i.  Indorsement  in  blank.  An  indorsement  in  blank  consists  of  the 
name  of  the  payee  or  holder,  written  in  the  customary  place  on 
the  back  of  the  instrument,  without  any  other  writing.  It  has  the 
effect  of  making  the  instrument  payable  to  bearer,  and  it  may  be 
legally  transferred  by  any  subsequent  holder,  without  any  further 
indorsement.  As  a  matter  of  fact,  however,  it  is  usual  for  each 
holder  to  be  required  to  indorse  the  instrument,  both  for  purposes  of 

174 


BUSINESS  VOUCHERS  AND  FORMS 


identification  and  to  add  his  guaranty  te»that  of  the  previous  indorsers. 
An  indorsement  in  blank  appears  as  follows: 


FRED  S.  LANE 


2.  Indorsement  in  full.  This  type  of  indorsement  consists  of  the 
words  "Pay  to  the  order  of,"  written  above  the  name  of  the  party  to 
whom  the  instrument  is  to  be  transferred,  with  the  signature  of  the 
indorser  appended.  This  has  the  effect  of  making  it  necessary  for  the 
party  to  whom  it  is  thus  transferred  to  indorse  it  again  in  order  to 
transfer  the  legal  title  to  any  subsequent  holder.  Where  negotiable 
papers  are  to  be  sent  through  the  mail,  or  are  to  be  held  for  some  time 
by  the  person  to  whom  they  are  transferred,  this  type  of  indorsement 
is  desirable,  since  it  serves  as  a  protection  against  any  improper  use 
being  made  of  the  instrument  in  case  it  falls  into  the  possession  of 
someone  other  than  the  legal  holder.  An  indorsement  in  full  takes 
the  following  form : 


Pay  to  the  order  of 
W.  A.  PETERSON 
HENRY  WILSON 


3.  Restrictive  indorsement.  A  restrictive  indorsement  is  one  which 
transfers  the  title  but  restricts  the  use  of  the  instrument.  Checks 
and  other  negotiable  instruments  sent  to  the  bank  for  deposit  should 
be  safeguarded  by  including  in  the  indorsement  the  words  "For 
Deposit."  This  prevents  their  use  for  any  other  purpose,  as  it  serves 
notice  on  anyone  to  whom  they  might  be  transferred,  and  prevents 
such  subsequent  transferee  from  acquiring  a  legal  title.  Many  business 
concerns  use  a  rubber  stamp  with  the  form  of  this  type  of  indorsement, 

bearing  the  words  "Pay  to  the  order  of Bank,  for  deposits," 

to  which  is  added  the  signature  of  the  depositor.     The  form  in  which 
such  indorsement  appears  is  as  follows: 


Pay  to  the  order  of 
THE  UNIVERSITY  STATE  BANK 

For  Deposit 
H.  L.  MURRAY 


1 76  PRINCIPLES  OF  ACCOUNTING 

4.  Qualified  indorsement.  wV  qualified  indorsement  is  one  which 
transfers  the  title  to  the  instrument,  but  does  not  guarantee  its  pay- 
ment. This  indorsement  is  accomplished  by  adding  the  words 
"  Without  Recourse."  When  an  instrument  is  so  indorsed  the  indorsee 
cannot  recover  from  the  indorser  if  the  maker  of  the  instrument  fails 
to  pay  it.  The  form  of  such  an  indorsement  is  as  follows: 


Pay  to  the  order  of 
THE  KENWOOD  TRUST  COMPANY 

Without  Recourse 
THOS.  H.  SHERIDAN 


The  proper  position  of  the  indorsement  on  a  negotiable  instrument 
is  on  the  back  of  the  instrument,  written  across  the  left-hand  end  of  the 
paper,  as  in  the  above  illustrations. 

Sometimes  partial  payments  are  made  on  negotiable  instruments, 
such  as  promissory  notes  and  time  drafts.  In  such  a  case,  it  is  cus- 
tomary for  the  holder  to  record  such  payments  on  the  back  of  the 
instrument  by  writing  the  date  and  the  amount  of  the  payment. 
No  signature  should  be-.attached  to  such  a  memorandum  on  the  back 
of  the  instrument,  since  such  signature  might  be  interpreted  as  an 
indorsement  and  open  the  way  to  an  improper  use  of  the  paper  by 
anyone  who  might  get  possession  of  it. 

A  negotiable  instrument  should  be  signed  or  indorsed  by  the 
party  or  parties  who  assume  the  responsibility  indicated  by  such 
signature  or  indorsement,  or  by  a  duly  authorized  agent.  In  a  part- 
nership known  as  a  "trading"  partnership,  as  distinguished  from 
partnerships  of  professional  men,  each  partner  has  the  power  to  sign 
negotiable  instruments  and  to  bind  the  firm  by  his  action,  provided 
such  instruments  are  given  in  connection  with  the  regular  conduct  of 
the  partnership  business.  In  a  corporation  the  by-laws  specify  who 
shall  be  authorized  to  sign  such  instruments.  In  the  case  of  a  nego- 
tiable instrument  bearing  the  signature  of  a  partnership  or  a  corpora- 
tion, not  only  the  signature  of  the  firm  appears  but  also  that  of  the 
duly  authorized  agent  who  signs  the  firm  name. 

Miscellaneous  business  forms.  •  Besides  the  special  class  of  nego- 
tiable vouchers  discussed  above,  and  the  vouchers  used  in  connection 
with  the  purchase  and  sale  of  merchandise,  there  are  a  great  number 


BUSINESS  VOUCHERS  AND  FORMS  177 

of  other  forms  which  may  arise  in  connection  with  business  trans- 
actions. It  is  neither  practicable  nor  useful  to  attempt  to  name  or 
discuss  all  of  these  forms  at  this  point,  but  certain  of  the  more  common 
ones  may  be  briefly  considered  here.  The  more  important  of  these 
forms,  for  present  purposes,  are  as  follows: 

1.  The  statement  of  account 

2.  The  receipt 

3.  The  bill  of  lading 

4.  Forms  used  in  connection  with  banking  transactions: 
a)  The  deposit  ticket 

6)  The  signature  card 

c)  The  pass  book 

d)  The  bank  statement 

e)  The  check  book 

The  statement  of  account.  It  has  already  been  explained  that 
when  goods  are  sold  an  invoice  or  sales  ticket  is  delivered  to  the 
customer,  giving  the  essential  facts  with  regard  to  the  sale,  including 
the  quantities  of  the  goods,  the  prices,  the  total  amount,  and  the 
terms  of  sale.  In  the  case  of  goods  sold  at  wholesale  each  invoice  is 
payable  at  a  certain  date,  and  the  customer  is  supposed  to  remit  on 
or  before  that  date  without  any  reminder  from  the  creditor.  How- 
ever, such  reminders  are  in  fact  frequently  necessary,  and  usually 
take  the  form  of  letters  requesting  a  remittance.  If  several  invoices 
are  due  and  unpaid  at  any  one  time,  the  creditor  may  send  a  statement 
of  the  amounts  of  such  invoices  and  the  total  due  to  date.  The  send- 
ing of  statements  of  account,  however,  is  not  a  usual  practice  among 
wholesale  businesses. 

Retail  sales  made  on  credit  are  usually  understood  to  be  on 
monthly  account,  unless  otherwise  specified,  and  since  the  customer 
cannot  be  reasonably  expected  to  keep  a  record  of  his  exact  indebted- 
ness and  remit  when  the  amount  is  due,  it  is  customary  for  retail 
establishments  to  send  each  customer  a  summary  of  his  account  at  the 
beginning  of  each  month.  This  serves  the  double  purpose  of  a  con- 
venience to  the  customer  and  of  facilitating  and  hastening  collections. 
Such  a  summary  is  known  as  a  "statement  of  account."  An  illus- 
tration of  the  form  of  statement  of  account  which  is  typical  of  the 
larger  retail  businesses  is  shown  on  page  1 78. 


PRINCIPLES  OF  ACCOUNTING 


To  avoid  delays  address  all  correspondence  direct  to  MANDEL 
BROTHERS,  State  to  Wabash  at  Madison  Street 

Bought  of 

MANDEL  BROTHERS 

CHICAGO 

May  i,  1920 
W.  S.  SCHULER 
912  E  53d  St. 
Chicago,  111.  7/3245 

Please  detach  and  return  this  Folio Amount 

coupon  with  your  remittance 


Bought  of  MANDEL  BROTHERS,  Chicago 


Payable  first  to  tenth  of  month  following  that  of  purchase 


March  $16.28 
April 

8251               5  i  pr.  low  shoes  11.10 

8762            15  2  shirts  $4.25            8.50 

9235            22  i  hat  10.50 

9568             22  4  pr.  hose  .75            3.00 

9568            25  2  pr.  hose  returned  .75                           $i .  50 

9783            25  i  dress  tie  i.oo 


Total  550.38 

Less  credits  i .  50 

$48.88 


Paid IQ Check  No_ Amount 


The  top  part  of  this  statement,  which  is  perforated  for  detachment 
from  the  lower  part,  is  really  another  kind  of  voucher.  It  is  a 
remittance  slip,  intended  to  be  detached  and  returned  with  the  remit- 
tance, and  is  used  by  the  selling  concern  as  a  voucher  for  the  recording 
of  cash  received  from  customers  in  payment  of  their  accounts.  The 
use  of  this  form  will  be  discussed  in  a  later  chapter. 

The  receipt.  A  receipt  is  a  written  acknowledgment  given  by 
the  party  receiving  money  in  discharge  of  an  obligation  to  the  one 
making  such  payment.  In  the  past  this  form  was  much  in  use,  but 
in  modern  business  practice  it  is  almost  obsolete.  Where  payments  are 


BUSINESS  VOUCHERS  AND  FORMS  179 

made  by  check,  as  is  the  general  practice,  the  canceled  check  from  the 
bank,  bearing  the  indorsement  of  the  creditor,  usually  serves  well 
enough  as  a  receipt.  Or  the  bill  or  statement  may  be  receipted  by 
stamping  on  its  face  some  such  form  as  the  following: 


Received  Payment 

June  3,  1920 

CENTRAL  SUPPLY  Co. 

Per 


Most  modern  business  concerns  do  not  return  to  the  customer 
any  form  of  receipt  other  than  that  of  the  canceled  check  which  he 
eventually  receives  from  the  bank,  bearing  the  creditor's  indorsement. 
If  the  customer  desires  a  receipt  which  can  be  identified  with  the 
particular  invoice  or  invoices  covered  by  the  check,  he  can  secure  this 
by  having  a  form  printed  on  the  check  for  the  entry  of  the  numbers  of 
the  invoice  covered,  or  of  any  other  information  of  similar  type. 

The  bill  of  lading.  In  connection,  with  the  work  of  marketing 
(buying  and  selling  goods),  one  very  important  function  which  must 
be  performed  is  that  of  transportation.  This  involves  dealings  with 
railroad  companies  and  other  transportation  agencies.  When  goods 
are  turned  over  to  a  railroad  company  for  shipment  the  shipper 
receives  from  the  railroad  company  an  instrument  which  constitutes 
evidence  of  the  contract  entered  into  between  the  two  parties,  and 
also  serves  the  shipper  as  a  receipt  for  the  delivery  of  the  goods  to  the 
carrier.  This  rather  formal  document  is  known  as  a  bill  of  lading. 
It  sets  forth  the  provisions  of  the  contract  under  which  the  carrier 
accepts  the  goods  for  shipment,  defines  the  carrier's  liabilities,  and 
states  the  duties  of  the  shipper  in  connection  with  such  shipment. 
The  form  of  the  bill  of  lading  is  a  standard  one,  being  prescribed  for 
the  use  of  all  the  roads  doing  interstate  business  by  the  Interstate 
Commerce  Commission.  In  case  the  shipper  wishes  to  have  the  bills 
of  lading  used  in  shipping  his  goods  printed  on  his  own  form  for 
convenience  in  filing  he  is  permitted  to  do  so,  provided  the  form  used 
conforms  to  the  requirements  of  the  standard  form. 

There  are  two  forms  of  the  bill  of  lading.  The  one  more  commonly 
used  is  known  as  the  straight  bill  of  lading.  In  this  form  the  goods 
are  consigned  to  the  party  who  is  eventually  to  receive  them,  and  the 


i8o  PRINCIPLES  OF  ACCOUNTING 

bill  of  lading  is  not  negotiable.  This  form  is  used  where  satisfactory 
credit  relations  exist  between  the  shipper  and  the  party  to  whom  the 
goods  are  shipped,  and  no  conditions  are  intended  to  be  attached  to 
the  receipt  of  the  goods  by  the  latter.  The  other  form  is  known 
as  the  order  bill  of  lading,  and  is  negotiable.  In  the  use  of  this  form, 
the  goods  are  consigned  to  the  shipper  or  some  agent  of  the  shipper, 
and  the  purchaser  cannot  get  the  goods  until  he  has  the  bill  of  lading. 
This  enables  the  shipper  to  withhold  actual  delivery  of  the  goods 
until  the  purchaser  has  satisfied  the  shipper's  conditions  with  respect 
to  payment  for  the  goods.  The  use  of  this  method  of  shipment  will 
be  discussed  more  fully  in  chapter  xvii. 

The  bill  of  lading  is  usually  made  out  hi  triplicate.  The  original 
is  signed  by  both  the  shipper  and  the  agent -of  the  carrier,  and  serves 
the  shipper  as  evidence  of  his  contract  with  the  transportation  com- 
pany, and  as  a  receipt  for  the  delivery  of  the  goods  to  the  company. 
This  copy  must  be  preserved  for  use  hi  case  of  any  claims  for  damages 
which  are  later  made  by  the  shipper.  The  second  copy  is  known  as 
the  shipping  order,  and  is  signed  only  by  the  shipper.  It  is  retained 
by  the  railroad  as  evidence  of  its  authorization  to  ship  the  goods. 
The  third  copy  is  a  duplicate  of  the  first,  being  signed  by  both  parties, 
and  given  to  the  shipper  as  a  duplicate  receipt.  It  may  be  sent  with 
the  invoice  to  the  consignee.  In  some  cities  where  a  central  traffic 
association  is  maintained  by  the  business  men  of  the  city,  a  fourth 
copy  is  made  for  filing  in  the  offices  of  this  organization. 

Forms  used  in  connection  with  transactions  with  the  bank.  It  has 
already  been  indicated  that  it  is  customary  for  business  men  to 
depoist  all  cash  (including  checks  and  other  bankable  paper)  received 
with  some  bank,  and  to  discharge  their  obligations  by  giving  the 
creditor  a  check  against  the  bank.  This  practice  is  almost  universal 
in  modern  business.  The  receiver  of  the  check  deposits  it  with  his 
own  bank,  which  credits  his  account  with  the  amount,  and  then 
collects  from  the  bank  on  which  the  check  is  drawn.  In  case  both 
deal  with  the  same  bank,  the  bank  merely  subtracts  the  amount  of 
the  check  from  the  account  of  the  drawer,  and  adds  it  to  the  account 
of  the  one  depositing  the  check.  Some  of  the  forms  in  common  use 
in  connection  with  banking  transactions  of  this  character  are :  (i)  the 
deposit  ticket;  (2)  the  signature  card;  (3)  the  pass  book;  (4)  the  bank 
statement;  (5)  the  check  book. 


BUSINESS  VOUCHERS  AND  FORMS 


181 


The  deposit  ticket.  When  a  depositor  makes  a  deposit  with  his 
bank,  he  fills  out  a  form  supplied  by  the  bank,  known  as  a  deposit 
ticket.  This  form  provides  for  a  record  of  the  name  of  the  depositor, 
the  date,  the  total  amount  of  currency,  gold,  and  silver  deposited,  and 
for  a  classification  of  the  checks  deposited.  A  form  of  such  a  deposit 
ticket  is  shown  below: 


May  s,  1920 
FIRST  NATIONAL  BANK 
CREDIT  ACCOUNT  OF 
\V\i.  J.  CONWAY 

CHECKS  ON  OTHER  BANKS 

CHECKS  ON  THIS  BANK 

Cont.  and  Com.  $i  25 

oo 

$212 

80 

Drovers  Nat'l.         65 

50 

Corn  Exchange      236 

25 

Total                      426 

75 

Total  Checks  on 

212 

80 

Total  Checks  on 
Other  Banks  

4a6 

75 

Currency  

168 

00 

Gold     

S3 

65 

20 

Total   . 

86  1 

0 

Less  Exchange  



860 

24 
QO" 

If  the  deposit  to  be  made  is  large  in  amount,  and  in  various  forms, 
the  following  suggestions  may  be  worth  while:  (i)  If  a  considerable 
number  of  coins  are  to  be  deposited,  they  should  be  wrapped  hi  con- 
venient amounts  in  coin  wrappers  provided  by  the  bank.  (2)  Paper 


182  PRINCIPLES  OF  ACCOUNTING 

money  should  be  arranged  in  the  order  of  its  denomination,  with  the 
smallest  bills  on  top.  (3)  Checks  should  be  arranged  in  the  order  in 
which  they  are  listed  on  the  deposit  ticket.  (4)  Each  check  should 
be  properly  indorsed.  (5)  The  items  should  be  totaled  and  the  total 
entered  in  the  space  provided. 

The  signature  card  used  for  identification  of  depositor's  signature. 
The  signature  card  is  merely  a  card  kept  in  the  records  of  the  bank 
by  means  of  which  the  signature  of  the  depositor  may  be  identified 
at  any  time.  The  depositor  is  required  to  fill  out  such  a  card  at  the 
time  he  opens  his  account  with  the  bank.  If  at  any  time  the  depositor 
desires  to  change  the  signature  that  is  to  be  honored  on  checks  against 
his  account,  a  record  of  this  change  must  be  given  the  bank. 

The  pass  book.  When  the  depositor  opens  his  account  with  the 
bank  and  makes  his  first  deposit,  he  is  given  a  book  known  as  a  pass 
book  in  which  a  record  is  made  of  each  deposit.  Whenever  he  makes 
a  deposit  he  is  supposed  to  bring  this  pass  book  and  present  it  to  the 
teller  along  with  the  deposit  slip.  The  teller  retains  the  deposit  slip 
as  a  basis  for  the  bank's  record  of  the  transaction,  and  enters  the 
amount  of  the  deposit  in  the  pass  book  to  serve  as  the  depositor's 
record  of  the  transaction.  Formerly  it  was  customary  for  the  deposi- 
tor to  leave  his  pass  book  at  the  bank  once  a  month,  when  the  amount 
of  his  withdrawals,  as  evidenced  by  his  canceled  checks  returned,  was 
entered  in  the  book,  being  subtracted  from  the  amount  of  the  balance 
at  the  beginning  plus  the  total  deposits  for  the  month  to  give  his 
balance  at  the  end  of  the  month.  This  practice  is  no  longer  generally 
followed.  Most  of  the  banks  now  present  monthly  statements  of  the 
depositor's  account  in  place  of  the  balanced  pass  book.  These 
statements  are  made  up  by  the  use  of  a  bank  posting  machine  which 
saves  labor  and  adds  to  the  accuracy  of  the  computations. 

The  bank  statement.  The  statement  rendered  by  a  bank  to  each 
of  its  customers  at  the  end  of  the  month  is  not  unlike  that  sent  out 
by  a  large  retail  establishment,  except  that  it  shows  a  balance  due  the 
customer  from  the  bank  instead  of  a  balance  due  the  store  from  the 
customer.  Some  banks  use  what  is  known  as  the  envelope  form  of 
statement,  which  means  simply  that  the  statement  is  made  out  on  the 
back  of  an  envelope,  in  which  the  canceled  checks  are  inclosed.  A 
form  of  bank  statement,  such  as  is  used  by  the  more  up-to-date  banks, 
is  illustrated  on  page  183. 


BUSINESS  VOUCHERS  AND  FORMS 


183 


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1 84  PRINCIPLES  OF  ACCOUNTING 

The  check.  Considerable  attention  has  been  given  in  the  preceding 
pages  to  the  nature,  form,  and  use  of  the  check.  Checks  are  ordi- 
narily issued  from  a  bound  book,  which  contains  stubs  for  entering 
the  details  of  each  check  issued.  The  check  and  the  stub  should  be 
filled  out  at  the  same  time,  both  bearing  the  same  serial  number. 
The  check  is  then  torn  off  at  the  perforation  and  issued,  while  the  stub 
is  kept  hi  the  book  as  a  record  of  the  issued  check.  If  accounts  are 
carried  with  more  than  one  bank,  a  different  check  book  will  be  used 
for  each  bank.  The  stubs  in  the  check  book  frequently  serve  as  a 
basis  for  the  entry  in 'the  cash  book  of  cash  disbursements  and  as 
vouchers  for  such  disbursements. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  Of  what  importance  to  the  business  man  is  a  knowledge  of  the  legal 
effect  of  the  various  methods  of  indorsement  ? 

2.  Do  you  consider  it  justifiable  to  devote  space  in  an  accounting  text  to 
a  discussion  of  forms  used  in  connection  with  banking  operations  ? 
Why,  or  why  not  ? 

3.  What  purposes  may  be  served  by  a  statement  of  account  like  the  one 
illustrated  on  page  178?    What  method  or  methods  might  be  employed 
in  preparing  such  a  statement  ? 

4.  What  is  "two-name  paper"?    Is  it  necessarily  more  acceptable  to  a 
bank  than  "one-name  paper"  ?    Discuss. 

5.  The  Columbia  Phonograph  Company,  of  New  York,  sells  a  large  order 
of  goods  to  the  Jones  Music  Company,  of  Chicago.    The  selling  com- 
pany is  doubtful  of  the  purchaser's  credit,  and  stipulates  that  the 
Chicago  office  of  the  seller  shall  collect  for  the  merchandise  before  it  is 
delivered  to  the  purchaser.    At  the  same  time  this  order  is  shipped 
a  consignment  of  goods  is  shipped  to  the  Chicago  branch  of  the  Colum- 
bia  Phonograph   Company  for  display  purposes.    What  method  of 
shipment  would  you  recommend  for  each  lot  of  goods  ?    Explain  your 
answer. 

6.  What  is  the  importance  of  the  bank  statement  to  the  accountant? 
What  uses  can  he  make  of  this  statement  ? 

7.  What  is  the  purpose  of  the  deposit  ticket  ?    Who  makes  it  out  ?    Is  the 
deposit  ticket  a  voucher  ?    Explain. 

8.  You  transfer  the  check  of  a  customer  to  a  creditor.    The  latter  presents 
it  to  the  bank  upon  which  it  is  drawn,  and  payment  is  refused  because 
the  maker  has  not  sufficient  funds  on  deposit.     In  what  way  will  this 
affect  you  ? 


BUSINESS  VOUCHERS  AND  FORMS  185 

9.  On  June  30  your  bank  statement  shows  a  balance  to  your  credit  of 
$1,500.00.  Your  records  show  that  your  bank  balance  is  $1,150.00. 
Explain. 

10.  Under  what  circumstances  might  a  negotiable  instrument  be  transferred 
wit  h  a  qualified  indorsement  ?     What  rights  have  subsequent  holders 
against  such  indorser  ? 

11.  If -a  retailer  sends  a  wholesaler  his  check  in  payment  of  an  account, 
does  he  expect  a  receipt  ?     If  not.  how  is  he  protected  against  paying 
again  ? 

REFERENCES  FOR  FURTHER  STUDY 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xxiv. 
MOULTON,  H.  G.,  Financial  Organization  of  Society,  chap.  xii. 

LABORATORY  EXERCISE  NO.  31— Concluded 

Instructions: 

In  charging  the  salaries  of  clerks,  the  salary  of  Harry  James  is  to  be 
considered  an  administrative  expense  and  the  salaries  of  all  others  are  to  be 
considered  a  selling  expense. 

Post  all  transactions  to  the  ledger  and  take  a  trial  balance. 

Make  a  statement  of  profit  and  loss  and  the  balance  sheet,  taking  into 
consideration  the  following  points: 

a)  Inventory  of  merchandise,  $2,900.00. 

b)  Depreciation  of  buildings,  i  per  cent. 

c)  Depreciation  on  office  furniture,  2  per  cent. 

Make  the  journal  entries  necessary  to  give  affect  to  the  adjustments 
stated  above  and  post  these  entries. 

Close  ledger  by  means  of  journal  entries,  rule  up  all  books  of  original 
entry. 


CHAPTER  XVI 
THE  ACCOUNTING  PROCESS 

Purpose  of  the  chapter.  In  the  preceding  chapters  it  was  intended 
to  present  in  the  simplest  possible  manner  the  various  steps  or 
processes  necessary  in  gathering,  recording,  summarizing,  and  inter- 
preting the  data  of  business  operations  from  the  point  of  view  of  mak- 
ing such  data  available  for  the  use  of  the  business  manager  in  planning 
and  controlling  the  future  operations.  Notwithstanding  the  effort 
to  simplify  this  presentation,  it  has  run  through  a  considerable  number 
of  pages  and  has  involved  a  considerable  amount  of  detail.  It  is  expe- 
dient, therefore,  to  give  a  brief  summary  of  the  various  steps  thus  far 
outlined. 

Accounting  reports.  Throughout  the  discussion  it  has  been  empha- 
sized that  the  aim  of  the  accounting  process  is  to  make  available 
the  information  needed  for  reports  to  the  management,  and  to  have 
this  information  classified  in  such  a  manner  as  to  make  these  reports 
as  useful  as  possible.  By  the  "management,"  as  the  term  is  here 
used,  is  meant  the  owners  of  the  business  or  the  persons  to  whom  these 
owners  have  delegated  their  managerial  authority.  It  is,  accordingly, 
to  the  owners  or  their  representatives  that  the  accounting  reports  are 
to  be  submitted,  and  it  is  to  their  peculiar  needs  that  the  presentation 
of  the  data  should  be  adapted.  It  must  be  remembered  that  the 
typical  owner  or  manager  is  not  a  man  trained  in  the  technicalities 
of  accounting.  The  reports  must  therefore  be  freed  from  such 
technicalities  hi  so  far  as  this  is  possible,  while  presenting  the 
information  which  will  be  of  the  most  use  to  the  manager  in 
question.  It  is  quite  evident  that  the  nature  of  such  information 
will  vary  with  the  nature  of  the  business  enterprise  and  with  its 
internal  organization.  This  means  that  the  information  needed  as  an 
aid  to  the  management  of  a  retail  clothing  store  would  be  of  a  different 
nature  and  would  be  classified  on  a  different  basis  from  that  needed  by 
the  management  of  a  shoe  factory.  It  means  also  that  the  infoi- 
mation  which  should  be  presented  for  the  use  of  the  management  of  a 

186 


THE  ACCOUNTING  PROCESS  '187 

small  clothing  store,  with  all  the  buying  and  the  entire  administration 
of  the  shop  in  the  hands  of  a  single  man,  would  be  quite  different  in 
the  amount  of  detail  and  in  the  classification  of  the  items  from  that 
needed  for  the  use  of  the  management  of  a  large  retail  clothing  estab- 
lishment with  several  departments  and  a  manager  in  charge  of  each 
department. 

In  both  cases,  however,  the  need  for  reports  of  some  kind  unmis- 
takably exists.  The  reports  for  the  manager  of  the  small  retail  store 
might  be  prepared  by  himself,  and  might  be  very  simple  indeed. 
The  big  clothing  store  might  maintain  a  considerable  staff  and  a 
complex  accounting  system  for  the  purpose  of  gathering  the  infor- 
mation, and  might  require  several  kinds  of  reports,  each  classifying 
the  information  on  a  different  basis  and  for  a  different  purpose.  In 
each  case,  however,  some  kind  of  reporting  is  necessary,  and  the 
accounting  system  and  records  must  be  designed  with  the  aim  of 
gathering  and  classifying  the  business  data  in  such  a  way  as  to  make 
this  reporting  possible.  In  designing  these  records  for  any  given 
business,  therefore,  one  should  first  determine  what  use  is  to  be  made 
of  the  data  and  then  set  up  the  records  which  will  best  perform  their 
function  of  furnishing  the  information  needed  in  preparing  each  of  the 
reports  needed. 

There  is  almost  no  limit  to  the  number  of  reports  which  may  be 
useful  in  a  large  business  with  a  number  of  subordinate  managers. 
There  are,  however,  two  reports  which  are  used  in  every  kind  of 
business.  These  two  reports,  which  furnish  certain  information 
about  the  business  as  a  whole,  will  be  considered  for  the  present  as 
typical  of  all  accounting  reports.  They  are:  (i)  the  balance  sheet, 
which  shows  the  amount  and  nature  of  the  assets,  liabilities,  and 
proprietorship  of  the  business  as  they  appear  at  a  stated  time;  (2)  the 
statement  of  profit  and  loss,  which  gives  the  amount  and  nature  of  the 
income  and  expenses  of  the  business  for  a  stated  period,  and 
the  difference  between  the  two — the  net  profit  or  loss  for  the  period. 

In  the  preceding  chapters  these  two  reports  have  been  used  to 
illustrate  the  function  of  reports  as  a  whole,  and  to  bring  out  the  rela- 
tionship between  the  reports  and  the  whole  accounting  process 
necessary  for  their  preparation.  They  have  been  used  for  this  purpose 
because  they  are  the  most  generally  used  of  all  accounting  reports, 
and  because  they  serve  better  than  any  other  forms  to  illustrate  the 


1 88  PRINCIPLES  OF  ACCOUNTING 

relationship  between  the  reports  and  the  accounting  process  as  a 
whole.  If  the  student  succeeds  in  understanding  thoroughly  the 
function  of  these  reports  and  their  relationship  to  the  accounting 
process,  it  should  not  be  very  difficult  for  him  to  understand  the  other 
forms  which  he  will  need  to  use  in  his  later  work. 

The  accounts.  It  was  explained  in  the  preceding  chapters  that  the 
accounting  reports  are  prepared  from  the  information  furnished  by 
the  accounts.  It  follows  that  the  number  and  nature  of  the  accounts 
to  be  kept  will  be  determined  by  the  information  which  is  to  appear  in 
the  reports.  For  each  item  of  information  which  is  to  be  shown  on 
any  accounting  report  there  must  be  maintained  an  account.  This 
rule  has  certain  exceptions  in  those  items  on  the  reports  which  are 
obtained  by  combining  other  items.  Examples  of  such  items  are 
"gross  profit  on  sales"  and  "total  current  assets."  The  accounts 
are  so  constructed  as  to  reflect  the  effect  of  every  business  transaction 
on  the  financial  condition  of  the  business.  The  nature  of  the  item 
whose  status  is  reflected  by  the  account  is  indicated  by  the  account 
title.  In  order  that  the  information  presented  by  the  accounting 
reports  shall  be  intelligible  and  free  from  ambiguity,  the  account 
titles  should  be  very  carefully  chosen  to  represent  in  each  case  exactly 
the  nature  of  the  item  in  question.  The  primary  function  of  the 
account  is  to  classify  and  keep  a  record  of  the  information  desired  for 
the  accounting  reports.  No  attempt  should  be  made,  therefore,  to 
prepare  a  list  of  accounts  to  be  used  by  any  business  until  the  nature 
of  the  reports  needed  by  that  business  and  the  information  to  be  shown 
by  each  such  report  have  been  determined.  It  is  for  this  reason  that, 
in  the  discussion  of  the  accounting  process  in  the  preceding  chapters, 
the  reports  were  considered  first. 

The  books  of  original  entry.  It  has  been  shown  that  every  business 
transaction  affects  certain  of  the  accounts,  and  that  this  effect  must 
be  recorded  in  every  account  so  affected.  But  for  various  reasons 
previously  explained  it  is  not  desirable  that  the  entries  for  the  trans- 
actions should  be  made  directly  to  the  accounts  themselves.  In- 
stead, a  record  of  each  transaction,  showing  all  the  accounts  affected 
and  the  manner  in  which  they  are  affected,  is  made  in  one  of  the  books 
of  original  entry,  from  which  the  information  is  later  "posted"  to  the 
proper  accounts.  The  number  of  such  books  of  original  entry  and 
the  nature  of  each  should  be  determined  by  the  number  of  types  of 


THE  ACCOUNTING  PROCESS  189 

transactions  occurring  in  the  business,  the  importance  of  each  type, 
and  the  classification  which  is  desired  of  each  kind  of  transaction. 
Whenever  a  given  type  of  transaction  becomes  frequent  enough  to 
assume  importance,  a  special  book  of  original  entry  should  be  provided 
for  recording  such  transactions.  All  transactions  for  which  no  such 
special  journal  is  provided  will  be  entered  in  the  general  journal. 
Each  book  of  original  entry  aside  from  the  general  journal,  should  be 
designed  to  provide  a  summary  of  all  transactions  of  a  certain  kind. 

In  the  ordinary  mercantile  business  the  transactions  which  occur 
most  frequently  are  those  involving  cash  receipts,  cash  disbursements, 
merchandise  purchases,  and  merchandise  sales.  For  this  reason  the 
special  journals  that  have  been  discussed  in  the  preceding  chapters 
for  purposes  of  illustration  are  the  cash  receipts  journal  and  cash 
disbursements  journal, .  which  together  compose  the  cash  book  or 
cash  journal,  the  purchases  journal,  and  the  sales  journal.  It  should 
be  remembered  that  any  special  form  of  book  of  original  entry  is  a 
journal,  and  any  entry  made  in  such  a  book  involves  debits  and 
credits  of  equal  amount.  In  making  an  entry  in  a  book  of  original 
entry,  therefore,  the  transaction  should  first  be  mentally  "journal- 
ized." That  is  to  say,  the  transaction  should  be  analyzed  with  regard 
to  its  effect  on  the  accounts  and  ultimately  on  the  reports  before  it  is 
entered  in  a  book  which  serves  as  a  basis  of  posting  to  the  accounts. 

Business  vouchers  and  forms.  The  information  which  serves  as  a 
basis  for  entering  a  transaction  in  the  proper  book  of  original  entry  is 
usually  furnished  by  some  form  of  voucher  arising  out  of  the  trans- 
action itself.  As  previously,  pointed  out,  such  vouchers  serve  not 
only  as  evidence  of  the  transactions  giving  rise  to  them,  and  as  a 
basis  of  entering  these  transactions  in  the  books  of  original  entry, 
but  also  in  many  cases  as  a  means  of  facilitating  the  transaction. 
There  are  certain  types  of  vouchers  which  serve  only  the  latter  pur- 
pose. One  very  important  class  of  vouchers  is  composed  of  the  papers 
arising  out  of  transactions  involved  in  the  purchase  or  sale  of  mer- 
chandise. Another  important  class  is  composed  of  those  papers 
which  serve  as  a  means  of  discharging  obligation  between  various 
individuals  and  firms.  This  class  has  certain  peculiar  features  which 
are  recognized  by  the  courts  and  embodied  in  the  statute  law  of  a 
number  of  states,  and  papers  of  this  class  are  known  as  negotiable 
instruments.  The  classification  under  which  vouchers  in  general  are 


igo  PRINCIPLES  OF  ACCOUNTING 

considered  in  a  previous  chapter  may  be  repeated  here,  as  follows: 
(i)  vouchers  used  in  connection  with  the  purchase  and  sale  of  mer- 
chandise; (2)  negotiable  instruments,  or  negotiable  vouchers;  (3) 
miscellaneous  vouchers  and  forms. 

The  accounting  process.  The  steps  outlined  in  the  foregoing  dis- 
cussion form  a  regular  sequence,  which  may  be  called  the  accounting 
process.  This  process  begins  with  the  performance  of  the  trans- 
action itself  and  ends  in  showing  in  the  reports  of  the  business  the 
effect  of  the  transactions  recorded.  The  steps  in  this  sequence,  in  the 
order  in  which  they  actually  occur,  may  be  indicated  as  follows: 
transactions — vouchers — books  of  original  entry — accounts — reports. 
Each  step  of  this  process  has  been  described  somewhere  in  the  pre- 
ceding pages.  The  transactions  which  are  performed  in  carrying  on 
the  business  operations  give  rise  to  various  types  of  vouchers  which 
serve  as  evidences  of  these  transactions,  and  as  a  basis  of  entering 
them.  From  these  vouchers  a  record  of  each  transaction  is  made  in 
the  appropriate  journal,  or  book  of  original  entry.  Each  of  these  books 
of  original  entry,  with  the  exception  of  the  general  journal,  is  designed 
for  the  recording  of  one  particular  class  of  transactions,  and  provides 
for  a  summary  of  all  the  transactions  of  that  class.  After  the  trans- 
actions have  been  entered  in  the  various  journals,  they  are  posted 
from  the  books  of  original  entry  to  the  accounts  in  the  ledger,  and  at 
the  end  of  the  period  a  summary  is  made  of  the  accounts,  and  the 
information  thus  obtained  is  used  in  the  preparation  of  the  reports. 
This  summariezs  the  accounting  process  of  all  businesses  which  have 
an  accounting  system,  though  the  process  will,  of  course,  vary  in  the 
amount  of  its  detail  and  in  the  complexity  of  the  routine  to  be  followed. 
It  is  not  to  be  supposed  that  the  forms  of  the  vouchers,  books  of 
original  entry,  and  reports  given  in  the  preceding  chapters  "for  pur- 
poses of  illustration  represent  standardized  forms  applicable  in  all 
businesses.  They  are  intended  only  to  be  suggestive  and  to  illustrate 
in  a  simple  way  the  fundamental  principles  involved  in  the  use  of  such 
forms.  These  fundamental  principles,  which  were  applied  in  working 
ou£  the  illustrations  given  in  the  first  part  of  the  course,  will  be  found 
to  apply,  with  few  exceptions,  to  any  sort  of  accounting  system  that 
may  be  under  consideration. 

The  order  which  has  just  been  indicated  as  the  order  in  which  the 
steps  of  the  accounting  process  actually  occur  is  not  the  order  in  which 


THE  ACCOUNTIMG  PROCESS  IQI 

they  have  been  discussed  in  the  preceding  chapters,  as  the  student 
will  readily  recall.  The  steps  have  been  taken  up  for  discussion  in 
exactly  the  reverse  order  to  that  in  which  they  take  place. 

The  reason  for  following  this  reverse  order  hus  been  explained 
more  than  once.  It  is  that  the  type  of  information  and  the  classi- 
fication of  this  information  which  is  desired  hi  the  reports  determines 
for  the  most  part  the  number  and  the  nature  of  the  accounts.  The 
information  which  is  desired  in  the  accounts  and  the  classification 
to  be  made  of  that  information  in  turn  determine  largely  the  number 
and  form  of  the  books  of  original  entry.  The  information  to  be 
recorded  in  the  books  of  original  entry  influences  to  a  considerable 
degree  the  information  which  will  need  to  be  provided  by  the  vouchers 
concerning  the  original  transactions.  Thus  by  following  the  order 
that  has  been  followed  in  the  consideration  of  the  accounting  process 
in  the  earlier  chapters,  it  is  possible  to  see  and  understand  the  factors 
which  affect  each  of  the  steps  in  the  accounting  process,  before  pro- 
ceeding to  a  consideration  of  that  step  itself. 

Importance  of  the  accounting  process.  The  student  need  not  hope  to 
be  able  to  familiarize  himself  with  all  the  various  accounting  systems 
and  forms  employed  by  business  concerns.  It  would  be  impossible  to 
do  this  during  a  college  course,  and  probably  even  during  a  lifetime. 
And  if  such  a  thing  were  possible,  it  would  scarcely  be  a  valuable 
form  of  knowledge.  If  the  student  has  a  working  knowledge  of  the 
nature  and  function  of  the  accounting  process,  he  should  experience 
little  difficulty  in  understanding  the  special  forms  and  records 
employed  by  any  business  as  a  part  of  its  accounting  system.  Also, 
he  should  be  able  readily  to  interpret  any  special  forms  of  reports 
that  may  come  before  him  in  case  his  work  lies  outside  the 
accounting  department. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  Explain    and    illustrate    the    relation    of    accounting    to    business 
management. 

2.  What  is  the  purpose  of  an  accounting  report  ? 

3.  What  are  the  two  reports  which  are  most  frequently  used  by  business 
men?    Discuss  the  uses  which  may  be  made  of  the  information  pre- 
sented in  each  of  these  reports. 

4.  How  are  the  assets  and  liabilities  of  a  business  classified  on  the  balance 
sheet  ?    Give  the  significance  of  this  classification. 


IQ2  PRINCIPLES  OF  ACCOUNTING 

5.  Give  the  points  which  you  would  regard  as  of  most  importance  in 
determining  the  financial  condition  of  a  business  from  its  balance  sheet. 

6.  What  items  have  to  be  considered  in  arriving  at  the  cost  of  goods  sold  ? 

7.  How  is  the  va^ue  of  the  inventory  which  appears  on  the  balance  sheet 
and  the  statement  of  profit  and  loss  determined  ? 

8.  Explain  and  illustrate  the  difference  between  operating   and  non- 
operating  expenses;  operating  and  non-operating  income. 

9.  What  determines  the  number  and  nature  of  the  accounts  kept  by  a 
business  ? 

10.  Explain  the  construction  of  accounts  with  fixed  assets. 
n.  What  is  meant  by  the  "balance"  of  an  account  ?    When  an  account  is 
"in  balance"  how  is  this  indicated? 

12.  Explain  how  the  number  and  nature  of  the  expense  accounts  which  a 
business  maintains  is  determined. 

13.  What  is  the  purpose  of  the  trial  balance  and  how  often  should  it  be 
made? 

14.  What  is  the  purpose  of  "adjusting"  entries?    Explain  and  illustrate 
how  they  are  made. 

15.  What  is  the  purpose  of  the  "closing"  entries?     Explain  and  illustrate 
how  they  are  made. 

16.  Why  are  entries  first  made  in  books  of  original  entry  instead  of  being 
entered  directly  in  the  accounts  ? 

17.  Give  the  principal  books  of  original  entry,  the  purpose  of  each  and  how 
each  is  posted. 

1 8.  Explain  and  illustrate  the  purpose  of  a  voucher. 

19.  WTiat  are  the  requisites  of  a  negotiable  instrument  ?    Illustrate  each. 

20.  Explain  and  illustrate  the  ways  in  which  a  negotiable  instrument  may 
be  indorsed. 

21.  What  is  meant  by  the  "accounting  process"  ?    Why  is  an  understand- 
ing of  this  process  important  ? 


CHAPTER  XVII 

BUSINESS  PRACTICE  AND  PROCEDURE- 
PURCHASES  AND  SALES 

Purpose  of  the  chapter.  In  chapter  xvi  the  successive  steps  of  the 
accounting  process  were  reviewed,  and  their  relations  to  one  another 
discussed.  In  the  present  chapter  the  business  transaction  and  the 
nature  of  the  routine  involved  in  handling  certain  of  the  more  common 
types  of  such  transaction  will  be  considered.  This  will  involve  a 
discussion  of  business  practice  and  a  further  consideration  of  the  use 
of  business  papers  in  handling  some  of  these  transactions. 

Methods  of  handling  purchases.  Under  present  business  practice, 
there  is  no  such  thing  as  a  standardized  purchase  routine.  The  rou- 
tine used  varies  with  the  nature  of  the  business  and  is  therefore 
usually  different  in  wholesale,  retail,  and  manufacturing  businesses. 
Also,  within  any  one  of  these  three  classes  the  purchase  routine  may 
be  expected  to  vary  somewhat  with  the  size  of  the  business,  the 
nature  of  the  goods  handled,  and  more  especially  with  the  organiza- 
tion of  the  business.  Thus  the  internal  organization  may  be  such  that 
all  the  purchasing  may  be  handled  by  the  proprietor,  by  one  of  the 
partners,  or  by  a  single  subordinate.  Or  a  single  purchasing  depart- 
ment may  be  provided,  headed  by  a  purchasing  manager  who  is  in 
charge  of  all  purchases.  Or  the  business  may  be  divided  into 
departments,  corresponding  to  a  certain  grouping  of  the  commodities 
sold,  and  the  head  of  each  department,  or  someone  under  him,  made 
responsible  for  the  purchase  of  all  merchandise  to  be  sold  in  that 
department.  With  this  last  form  of  organization  there  would  usually 
still  be  a  purchasing  department  for  the  entire  business,  the  head  of 
this  department  being  responsible  for  the  purchase  of  supplies  for  the 
entire  establishment.  In  addition,  there  may  be  an  official  known  as 
the  merchandise  manager,  who  exercises  a  general  supervision  over 
the  work  of  all  the  departmental  buyers. 

The  single  purchase  manager,  responsible  for  all  purchases  for  the 
business  and  heading  a  special  purchasing  department,  is  usually  to 

193 


194  PRINCIPLES  OF  ACCOUNTING 

be  found  in  a  manufacturing  business,  while  the  departmental  organi- 
zation, with  each  department  head  responsible  for  the  merchandise 
purchases  within  his  department,  is  characteristic  of  wholesale  busi- 
nesses and  the  larger  retail  establishments. 

The  purchase  requisition.     Where  the  organization  provides  for  a 
general  purchasing  agent,  he  may  make  a  large  part  of  his  purchases 


PURCHASE  REQUISITION 
Date  Au&-  4 From  W.  H.  S. 


Quantity        SM 

Article     %  *  Hexagonal  Nuts 


Date  required 

Advise  Mr.    Jordan on  delivery 


Required  far    Production  Order  No.  g8 


Purchase  Order  No.  475       Date 
Issued  to    W.  F.  Hebard  Co. 


Originated  by  H.  G.  M.    Approved  by    L.  C.  M. 


according  to  a  predetermined  plan,  drawn  up  by  him  after  conference 
with  others  of  the  managerial  staff,  and  representing  his  judgment  of 
the  ordinary  needs  of  the  business.  Large  purchases  in  advance  of 
actual  needs  may  sometimes  be  made  by  him  when  market  conditions 
make  it  seem  desirable  to  build  up  a  reserve  stock  of  certain  articles. 
Still  other  purchases  may  be  made  at  the  request  of  other  departments 


BUSINESS  PRACTICE  AND  PROCEDURE  195 

of  the  business,  to  fill  special  needs  that  will  arise  from  time  to  time. 
An  example  of  this  is  a  purchase  of  steel  castings  required  for  the 
manufacture  of  a  special  order  received  by  a  manufacturing  company. 
In  cases  where  request  is  made  of  the  purchasing  agent  for  the  pur- 
chase of  any  particular  lot  of  material,  such  request  usually  follows 
a  regular  form,  known  as  a  purchase  requisition.  The  essentials  of 
a  purchase  requisition  are  indicated  by  the  illustration  shown 
on  page  194. 

The  purchase  order.  Regardless  of  the  nature  of  the  purchasing 
organization,  or  of  the  kind  of  goods  that  are  to  be  purchased,  there 
must  always  issue  some  sort  of  purchase  order  from  the  purchasing 
concern  to  the  one  from  which  the  goods  are  purchased.  And  hi 
a  business  establishment  where  any  systematic  attempt  at  record 
keeping  is  made,  such  an  order  will  be  in  writing,  or  will  be  confirmed 
in  writing,  and  at  least  one  copy  will  be  kept  for  the  files  of  the  pur- 
chasing concern.  Ordinarily  there  will  be  a  regular  printed  form  for 
purchase  orders,  and  this  form  will  be  filled  out,  with  one  or  more 
carbon  copies,  each  time  an  order  is  sent.  In  a  small  business  with 
simple  organization,  it  is  sufficient  to  have  the  order  made  out  in 
duplicate,  the  original  sent  to  the  seller,  and  the  copy  retained  in  the 
office.  But  in  a  large  business,  or  one  with  a  more  elaborate  organiza- 
tion, there  may  be,  besides  the  original  order,  the  following  copies: 
(i)  a  copy  to  be  retained  by  the  purchasing  department;  (2)  a  copy 
to  be  sent  to  the  department  where  the  purchase  requisition  origi- 
nated; (3)  a  copy  for  the  accounting  department;  (4)  a  copy  for  the 
receiving  clerk  (this  copy  is  often  left  blank  as  to  quantities,  so  that 
the  quantities  may  be  filled  in  upon  receipt  and  count  of  the  goods 
themselves) ;  (5)  a  copy  for  the  stores  clerk  or  store  keeper,  so  that 
he  may  know  not  only  what  goods  are  on  hand  but  what  are  ordered 
and  when  delivery  may  be  expected. 

The  information  furnished  by  the  purchase  order  varies  somewhat 
in  different  businesses,  but  the  information  usually  considered  essential 
is  provided  in  the  order  blank  illustrated  on  page  196. 

The  form  shown  above  is  a  simple  one.  For  a  more  elaborate 
form  the  student  is  referred  to  the  illustration  of  the  sales  order  shown 
on  page  198,  since  from  the  point  of  view  of  the  purchasing  concern 
that  form  represents  a  purchases  order. 


PRINCIPLES  OF  ACCOUNTING 


THE  CENTRAL  SUPPLY  COM! 
INDIANAPOLIS 
Date                            19                 Req.  No.                         T 

•ANY 

'urch  Ord.  N 
.Via 

o. 

To  

Addres 
Ship  to 
Shipme 

3  R.  R  

nt  to  be  made  Terms 

t 

Signed 

The  purchase  invoice.  The  purchase  invoice,  which  was  discussed 
in  chapter  xiv,  is  usually  received  from  the  seller  before  the  goods 
arrive.  The  form  of  such  an  invoice  is  shown  on  page  162.  The 
invoice  should  be  sent  first  to  the  purchasing  department  or  to  the 
member  of  the  organization  who  is  responsible  for  the  purchase,  and 
should  there  be  checked  to  ascertain  whether  it  agrees  with  the  pur- 
chase order  in  quantities,  prices,  and  terms.  When  the  shipment  of 
goods  arrives,  it  should  be  checked  to  see  if  the  quantity  is  correct, 
and  the  purchasing  agent,  department  head,  or  other  responsible 
individual  should  make  sure,  by  tests  if  necessary,  that  the  quality  is 
satisfactory  and  according  to  the  purchase  agreement.  In  checking 
the  quantity  of  goods  received,  the  invoice  may  be  used  or  the  receiving 
department  may  make  a  separate  report  on  quantities,  received,  which 
is  then  compared  with  the  invoice  and  with  the  purchase  order.  This 
report  is  often  made  by  filling  hi  the  quantities  on  a  copy  of  the  pur- 
chase order  from  which  the  quantities  have  been  omitted  for  that 
purpose. 


BUSINESS  PRACTICE  AND  PROCEDURE  197 

When  the  invoice  has  been  verified  in  every  essential  respect, 
it  goes  to  the  accounting  department,  where  the  extensions  are 
verified,  and  is  then  used  as  a  basis  for  recording  the  purchase.  If 
the  amount  of  the  invoice  differs  from  what  the  purchaser  considers 
the  correct  figure,  it  may  be  entered  at  the  face  of  the  invoice  and  a 
claim  put  in  for  an  adjustment  to  bring  about  the  necessary  .correc- 
tions, or  its  entry  may  be  postponed  until  the  purchaser  and  seller 
have  come  to  an  agreement  on  the  matter. 

Methods  of  handling  sales — the  sales  order.  The  methods  employed 
in  making  sales  and  in  conducting  the  sales  routine  also  vary  quite 
widely  with  the  nature  of  the  particular  business  and  with  the  manner 
of  its  internal  organization.  But  whether  the  business  is  large  or 
small,  and  whether  sales  are  made  at  wholesale  or  at  retail,  the  sales 
transaction  always  starts  with  the  sales  order.  The  sales  order  as  it 
comes  from  the  customer  may  be  either  written  or  oral.  In  a  whole- 
sale business  the  order  may  come  directly  from  the  customer,  by  mail 
or  by  telegram,  in  written  form.  It  may  be  given  orally  by  the  cus- 
tomer to  a  salesman,  either  at  the  salesrooms  of  the  selling  concern 
or  at  the  customer's  place  of  business.  Or  it  may  be  given  by  the 
customer  over  the  telephone.  In  any  case  the  procedure  is  usually 
to  make  out  the  order  on  a  regular  house  form,  drawn  up  in  such  a  way 
as  to  facilitate  the  various  steps  involved  in  filling  the  order.  Where 
the  customer  sends  in  a  written  order  on  his  own  form,  this  can  be 
used  by  stamping  on  it  a  form  providing  for  a  check  on  each  of  the 
various  steps.  An  illustration  of  a  sales  order,  showing  what  informa- 
tion would  usually  be  sought,  is  shown  on  page  198. 

The  sales  order  in  the  wholesale  establishment,  once  made  out, 
ordinarily  goes  first  to  the  credit  department  for  approval.  If 
approved  there,  it  is  usually  listed- in  an  order  book  or  order  register 
to  avoid  losing  track  of  it.  It  may  then  be  sent  to  the  pricing  depart- 
ment to  have  the  prices  entered,  if  this  has  not  been  done  earlier. 
The  next  step  is  to  send  the  order  to  the  stock  room,  where  the  goods 
are  set  out,  each  item  being  checked  on  the  order  as  it  is  selected. 
The  order  and  the  goods  are  then  turned  over  to  the  shipping  depart- 
ment, where  the  goods  are  packed,  marked,  and  shipped,  and  the  order 
is  checked  to  indicate  that  the  goods  have  been  shipped.  The  order 
then  goes  back  to  the  office.  If  an  order  register  is  kept,  an  entry  will 
be  made  in  it  to  show  that  the  order  has  been  shipped.  The  order  is 


PRINCIPLES  OF  ACCOUNTING 


< 

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HIBBARD,  S: 

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Estimate                        D 

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Date     Time 

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ate  of  shipment. 

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Check 

Quantity 

Items 

List 
Price 

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Price 

Extensions 

• 

then  used  as  a  basis  for  making  out  the  sales  invoice,  and  either  the 
order  itself  or  a  copy  of  the  invoice  is  sent  to  the  accounting  depart- 
ment to  serve  as  a  basis  of  recording  the  sales  transaction.  This 
discussion  of  the  use  made  of  the  sales  order  contemplates  an  order 
made  out  on  a  house  form  of  the  selling  concern,  with  one  or  more 


BUSINESS  PRACTICE  AND  PROCEDURE  199 

copies.  Where  no  copy  of  the  order  exists  except  the  one  sent  by  the 
purchaser,  the  invoice  might  be  made  out  at  once  and  a  copy  of  the 
invoice  used  as  a  basis  for  the  routine  just  described. 

The  sales  invoice.  In  a  retail  establishment  orders  may  come  in 
any  form,  but  are  typically  given  orally  by  the  customer.  The  order 
is  filled  immediately,  and  the  sales  ticket  is  made,  usually  in  duplicate. 
One  of  these  copies  goes  to  the  customer  and  the  other  serves  as  a 
basis  of  analyzing  and  entering  the  sales  transactions  in  the  accounting 
department.  In  many  of  the  larger  establishments  additional  copies 
are  used. 

In  a  wholesale  business  at  least  two  copies  of  the  sales  invoice  are 
filled  out,  and  usually  a  greater  number.  Besides  the  original,  which 
goes  to  the  customer,  other  copies  may  be  required  as  follows: 

1.  A  copy  for  the  files  of  the  accounting  department,  where  it 
may  be  used  for  the  following  purposes: 

a)  As  a  basis  of  entering  the  transaction 

b)  To  be  filed  in  a  "tickler"  file  until  paid 

c)  To  be  kept  for  possible  reference  in  an  audit  at  the  end  of  the 
account  period 

d)  To  furnish  any  information  concerning  sales  not  shown  by 
the  ledger  accounts,  which  may  be  desired  in  the  preparation 
of  special  reports,  such  as  sales  estimates 

2.  A  copy  for  the  "tickler"  file  kept  on  unpaid  invoices  by  the 
credit  department,  assuming  this  to  be  separate  from  the  accounting 
department. 

3.  A  copy  for  the  sales  manager,  who  may  wish  to  obtain  from  the 
invoices  some  special  information  concerning  sales,  such  as  the  amount 
sold  by  each  of  his  salesmen. 

4.  A  copy  for  the  office  of  the  treasurer,  who  may  wish  to  use  the 
sales  tickets  as  a  basis  for  estimating  the  funds  that  will  be  available 
from  this  source  in  the  near  future. 

Shipping  or  delivery  of  merchandise.  It  is  apparent  that  a  part  of 
the  process  of  filling  a  sales  order  consists  in  shipping  or  delivering  the 
goods  to  the  customer.  In  a  retail  store  this  may  mean  merely  wrap- 
ping the  goods  and  handing  them  to  the  customer  at  the  time  of  the 
sale,  or  it  may  mean  delivering  the  goods  through  the  delivery  service 
of  the  store.  Neither  method  involves  any  problems  that  need  to  be 
discussed  in  this  chapter. 


200  PRINCIPLES  OF  ACCOUNTING 

In  a  wholesale  business,  however,  a  large  part  of  the  sales  are 
often  made  to  customers  outside  the  city,  and  practically  all  sales 
require  arrangements  for  their  delivery.  Leaving  out  of  consideration 
all  city  deliveries,  which  may  be  delivered  by  the  concern's  own 
trucks  or  contracted  for  with  a  transfer  company,  out-of-town  deliv- 
eries may  be  made  by  freight,  express,  or  parcels  post.  In  shipping 
goods  by  express  the  shipper  receives  from  the  carrier  an  express 
receipt.  In  shipping  by  freight  he  receives  a  bill  of  lading,  the  form 
of  which  has  already  been  discussed. 

In  shipping  by  freight  when  credit  matters  have  been  satis- 
factorily arranged,  the  "straight"  bill  of  lading  is  used,  by  which  the 
goods  are  consigned  direct  to  the  purchaser,  who  is  notified  by  the 
carrier  as  soon  as  the  goods  arrive  and  proceeds  to  get.  them  without 
further  ceremony.  But  where  the  seller  is  unwilling  to  relinquish  the 
goods  without  receiving  payment  the  shipment  is  made  by  an  "order" 
bill  of  lading,  in  which  the  shipper  or  his  agent  is  made  the  consignee. 
A  draft  is  drawn  by  the  shipper  upon  the  purchaser,  and  this  draft 
is  attached  to  the  bill  of  lading.  The  latter,  with  the  attached  draft, 
may  then  be  forwarded  to  some  agent  of  the  shipper  in  the  city  to 
which  the  goods  are  shipped,  or  more  usually  deposited  with  the 
seller's  home  bank.  The  bank  proceeds  to  forward  the  papers  to  its 
correspondent  bank  in  the  purchaser's  city.  In  the  meantime  the 
purchaser  will  be  given  notice  of  the  method  of  shipment  and  where  the 
bill  of  lading  can  be  obtained.  Only  by  paying  the  draft  is  he  able 
to  secure  the  bill  of  lading  and  so  get  the  goods  from  the  carrier.  This 
method  of  shipment  is  known  as  shipment  "by  bill  of  lading  with 
draft  attached." 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  What  persons  should  you  expect  to  be  responsible  for  purchases  of 
merchandise,  raw  materials,  or  supplies  in  each  of  the  following  busi- 
nesses: 

a)  A  retail  shoe  store  ? 

b)  A  wholesale  hardware  business? 

c)  An  automobile  factory  ? 

d)  A  department  store  ? 

e)  A  mail  order  business  ? 

2.  What  is  a  purchase  requisition?    What  advantages  are  there  in  the 
use  of  such  a  requisition  ? 


BUSINESS  PRACTICE  AND  PROCEDURE  201 

3.  In  which  of  the  businesses  listed  under  Question  i  should  you  expect  to 
find  purchase  requisitions  in  use  ?     For  what  type  of  purchases  would 
requisitions  be  used  in  each  case  ? 

4.  W.  D.  Allen  &  Company,  a  wholesale  hardware  business,  order  a  ship- 
ment of  cutlery  from  the  William  B.  Simmons  Company,  of  St.  Louis. 
What  items  of  information  should  the  purchase  order  furnish  ?    What 
purpose  does  each  such  item  of  information  serve  ? 

5.  How  many  copies  of  the  purchase  order  do  you  think  W.  D.  Allen  & 
Company  should  have  made  ?    What  purpose  would  each  copy  serve  ? 

6.  When  W.  D.  Allen  &  Company  receive  the  purchase  invoice  for  the 
goods  ordered,  what  procedure  should  be  followed  before  recording  this 
invoice  in  the  purchases  journal  ? 

7.  What  would  be  the  nature  of  the  sales  orders  received,  and  the  sources 
from  which  such  orders  might  be  received,  in  each  of  the  businesses 
listed  in  Question  i  ? 

8.  When  the  William  B.  Simmons  Company  made  out  the  invoice  for  the 
goods  shipped  to  W-D.  Allen  &  Company,  how  many  copies  do  you 
think  they  should  make  ?    What  use  might  be  made  of  each  copy  ? 

9.  Suppose  the  Simmons  Company  were  unwilling  to  sell  to  the  Allen 
Company  on  credit.     What  method  or  methods  of  collection  might 
they  employ  in  order  to  protect  themselves  ? 

10.  Why  do  different  business  organizations  have  different  methods  of 

handling  purchasing  routine?    Would  it  not  simplify  matters  if  a 

uniform  routine  were  followed  ? 
n.  What  items  of  information  are  ordinarily  recorded  on  the  retail  sales 

ticket  ?    Suggest  how  each  such  item  of  information  may  be  of  use  to 

the  management. 
12.  Upon  what  information  would  the  buying  program  of  a  departmental 

head  in  a  department  store  be  based  ?    Suggest  some  facts  that  might 

limit  the  extent  of  his  purchases. 

REFERENCES  FOR  FURTHER  STUDY 

GREENDLINGER,  LEO,  Financial  and  Business  Statements,  pp.  48-57. 
JONES,  E.  D.,  The  Administration  of  Industrial  Enterprises,  chap.  xvii. 


CHAPTER  XVIII 

BUSINESS  PRACTICE  AND  PROCEDURE— Concluded 

Cash  receipts.  The  procedure  involved  in  handling  the  cash  of  a 
business,  using  the  term  "cash"  in  the  accounting  sense,  is  of  con- 
siderable importance,  since  a  careless  handling  may  offer  tempting 
opportunities  for  its  misappropriation,  with  comparatively  slight 
chances  of  detection.  Taking  up  first  the  matter  of  cash  receipts, 
it  is  apparent  that  cash  is  received  from  several  sources  and  hi 
several  forms.  Some  sources  of  cash  receipts  are:  (i)  cash  taken  hi 
direct  payment  for  goods  sold;  (2)  cash  collected  from  customers  on 
open  account;  (3)  cash  received  hi  payment  of  notes  and  drafts; 
(4)  cash  from  the  sale  of  assets  other  than  merchandise;  ^(5)  cash 
secured  by  short- time  borrowing  at  the  bank;  (6)  cash  secured  through 
long-time  borrowing  or  the  sale  of  securities. 

Some  of  the  forms  in  which  cash  is  received  are  as  follows: 
(i)  checks;  (2)  currency;  (3)  postal  and'  express  money  orders; 
(4)  stamps;  (5)  bank  credits,  arising  from  notes  discounted,  interest 
on  bank  balances,  or  collections  deposited  to  the  firm's  account. 

All  cash  received,  no  matter  what  its  form  or  source,  should  be 
recorded  in  two  places:  (i)  in  the  cash  book  of  the  business  and  (2)  on 
the  record  kept  by  the  business  of  its  relations  with  the  bank.  That 
is  to  say,  all  the  cash  receipts  of  any  business  should  be  deposited  in 
the  bank.  Such  deposit  should  be  made,  as  far  as  is  possible,  on  the 
day  of  receipt.  The  fact  that  a  record  of  the  firm's  bank  balance  is 
kept  by  both  the  depositor  and  the  bank  acts  as  a  check  on  the 
correctness  of  the  records  of  cash  transactions. 

In  a  retail  establishment  the  two  chief  sources  of  cash  receipts 
are  cash  sales  and  collections  from  customers  on  account.  Receipts 
of  cash  from  sales  are  verified  by  checking  the  actual  cash  received 
with  the  totals  of  the  cash  sales  tickets,  after  which  a  record  of  such 
receipts  is  made  hi  the  cash  book  and  the  cash  sent  in  for  deposit. 
The  second  great  source  of  receipts,  remittances  through  the  mail 
from  customers,  is  also  the  chief  source  hi  a  wholesale  establishment. 


BUSINESS  PRACTICE  AND  PROCEDURE  203 

In  either  a  wholesale  or  a  retail  business  of  any  considerable  size, 
therefore,  the  manner  in  which  the  incoming  mail  is  handled  is  of 
considerable  importance.  It  is  well  to  have  one  responsible  person, 
preferably  a  member  of  the  firm  or  an  officer  of  the  company,  to  take 
charge  of  all  remittances  so  received.  In  the  larger  retail  establish- 
ments it  is  usual  for  each  check  to  be  accompanied  by  a  "  remittance 
slip,"  which  is  sometimes  the  statement  of  account  itself,  but  generally 
a  coupon  which  accompanies  the  statement  and  which  is  detached 
and  inclosed  with  the  remittance.  Such  a  remittance  slip  serves  as  a 
basis  for  recording  in  the  cash  journal  the  receipt  of  cash  from  the 
customer,  and  also,  as  will  appear  later,  for  posting  to  his  account. 
After  listing,  either  on  an  adding-machine  tape  or  on  a  special  form  of 
memorandum  blank,  ah1  checks  or  other  forms  of  remittance,  this 
adding-machine  tape  or  other  form  of  memorandum  serving  the  same 
purpose  is  sent  to  the  accounting  department  to  be  used  in  making 
the  records.  The  checks  and  other  forms  of  cash  received  are  sent  to 
the  cashier  to  be  taken  care  of  and  deposited.  Some  variation  of  this 
procedure  is  permissible,  but  it  is  not  ordinarily  desirable  that  the 
man  who  opens  the  mail,  the  one  who  records  the  receipts  hi  the  cash 
book,  and  the  one  who  deposits  the  cash  should  be  the  same  man, 
since  such  a  situation  offers  too  great  an  opportunity  for  the  mis- 
appropriation of  funds. 

At  the  end  of  the  month,  as  soon  as  the  monthly  statement  from 
the  bank  is  available,  it  should  be  possible  to  check  the  cash  receipts 
against  the  bank's  record  of  deposits,  and  to  establish  an  equality 
between  the  total  receipts  for  the  month  and  the  total  deposits. 
Amounts  placed  to  the  credit  of  the  business  on  the  books  of  the  bank, 
arising  from  discounted  notes,  interest  items,  or  collections,  must 
also  be  recorded  in  the  cash  book  as  cash  receipts,  so  that  such  items 
shall  not  disturb  the  equality  between  receipts  and  deposits. 

Cash  disbursements.  In  the  foregoing  discussion  of  cash  receipts 
it  was  pointed  out  that  by  depositing  all  cash  received,  a  check  on  the 
correctness  of  the  entries  on  the  receipts  side  of  the  cash  book  is 
available  in  the  monthly  bank  statement.  An  equally  effective 
check  can  be  maintained  on  the  cash  disbursements  if  every  cash 
disbursement  entered  hi  the  cash  book  is  effected  by  means  of  a  check. 
It  is  evident,  however,  that  there  are  many  cash  disbursements  of  such 
a  small  amount  that  it  would  be  inconvenient  and  in  fact  impracticable 


2O4 


PRINCIPLES  OF  ACCOUNTING 


to  draw  a  check  for  each  one  of  them.  This  difficulty  can  be  avoided 
and  the  general  cash-book  record  still  kept  in  agreement  with  the  bank 
statement  by  maintaining  what  is  known  as  a  petty  cash  fund. 

Petty  cash  funds.  A  petty  cash  fund  is  a  sum  taken  out  of  general 
cash  and  set  aside  for  the  purpose  of  making  small  payments  in 
currency.  No  matter  how  it  is  administered  or  what  method  is  used 
in  accounting  for  it,  it  will  be  originally  established  by  drawing  a 
check  for  the  amount  to  be  made  available  for  this  purpose.  An  entry 
will  be  made  in  the  general  cash  book  debiting  petty  cash  and  crediting 
cash  for  the  amount  of  the  check.  From  this  point  on  there  are  two 
methods  in  common  use  for  handling  the  fund. 

One  of  these  methods  is  to  carry  an  account  in  the  ledger  with 
petty  cash  which  will  reflect  all  the  fluctuations  in  the  amount  of  this 
fund.  A  petty  cash  journal  would  be  used  which  would  serve  as  a 
medium  for  posting  to  all  the  accounts  affected  by  petty  cash  expen- 
ditures. Such  a  journal  might  assume  the  following  form: 

PETTY  CASH  JOURNAL 


DATE 

EXPLA- 
NATION 

PETTY 
CASH 
DR. 

DISBURSEMENTS 

Adminis- 
trative 
Expenses 
Dr. 

Selling 
Expenses 
Dr. 

Sundry  Accounts 

PETTY 
CASH 
C«. 

Name 

Folio 

Amount 

The  petty  cash  account,  when  posted  to  date,  would  show  the 
amount  in  the  petty  cash  fund  at  the  time.  Every  check  drawn  to 
reimburse  the  fund  would  be  entered  in  the  cash  disbursements  journal 
as  a  debit  to  petty  cash  and  a  credit  to  cash. 

The  imprest  system  for  petty  cash.  The  other  method,  which  is 
probably  more  generally  used  in  large  concerns,  is  known  as  the 
imprest  system.  When  this  system  is  employed,  the  petty  cash  book 
is  not  ordinarily  used  as  a  posting  medium  but  only  as  a  subsidiary 


BUSINESS  PRACTICE  AND  PROCEDURE 


205 


record.  When  the  fund  is  depleted,  the  one  in  charge  of  the  fund 
prepares  a  statement  in  which  he  lists  the  expenditures  made  since  the 
last  check  was  drawn  to  petty  cash  and  classifies  them  according  to 
the  accounts  to  be  debited.  This  statement,  accompanied  by  some 
form  of  receipt  or  voucher  for  each  of  the  expenditures,  evidencing 
their  bona  fide  nature,  is  submitted  to  the  general  cashier  or  disbursing 
officer.  The  latter  then  draws,  or  authorizes  to  be  drawn,  a  check  for 
the  amount  necessary  to  bring  the  fund  up  to  the  original  sum.  The 
entry  in  the  general  cash  book  is  a  debit  to  each  of  the  accounts  shown 
by  the  petty  cash  analysis  to  be  chargeable,  and  a  credit  to  cash. 
Thus  the  showing  of  the  petty  cash  account  in  the  ledger  does  not 
change,  but  remains  always  at  the  same  figure.  The  debits  to 
accounts  affected  by  petty  cash  expenditures  are  made  through  the 
medium  of  the  general  cash  book,  and  not  through  the  petty  cash 
book,  as  under  the  other  method. 

Under  this  method  the  petty  cash  book,  being  only  a  subsidiary 
record,  may  assume  whatever  form  is  convenient  under  the  circum- 
stances. A  possible  form  for  such  a  record  is  shown  below: 

PETTY  CASH  BOOK 


Date 

Explanation 

Receipts 

Administra- 
tive Expenses 

Selling 
Expenses 

Miscel- 
laneous 

• 

To  illustrate  this  use  of  the  petty  cash  fund  it  may  be  assumed 
that  a  fund  is  established,  the  amount  of  which  is  set  at  $100.  A 
check  is  drawn  for  that  amount,  petty  cash  being  debited  and  cash 
credited.  The  one  in  charge  of  the  fund  cashes  the  check  and  uses 
the  currency  for  making  small  cash  payments.  Sooner  or  later  the 
fund  will  be  depleted  and  must  be  renewed.  Assume  that  the  amount 
remaining  in  the  fund  is  $14.50,  and  that  of  the  $85.50  which  has  been 
expended,  $49.60  is  chargeable  to  administrative  expense  and  the 


206  PRINCIPLES  OF  ACCOUNTING 

rest,  $35.90,  to  selling  expense.  A  statement  will  be  handed  to  the 
cashier  accounting  for  the  entire  amount  spent  and  showing  the  amount- 
chargeable  to  each  account.  He  will  accordingly  draw  a  check  for 
$85.50,  debiting  administrative  expense  with  $49.60,  selling  expense 
with  $35.90,  and  crediting  cash  with  $85.50. 

It  is  desirable  that  such  an  adjustment  should  be  made  at  the  end  of 
each  accounting  period,  so  that  the  total  of  expense  for  the  period  and  of 
cash  actually  available  at  the  end  of  the  period  may  be  correctly  shown. 

Method  of  handling  notes  receivable  and  payable.  In  case  the  size 
or  nature  of  the  business  is  such  that  notes  received  are  few  in  number, 
they  may  be  recorded  in  the  general  journal  and  posted  item  by  item 
from  that  book  to  the  notes  receivable  account.  If  transactions  in- 
volving notes  receivable  occur  rather  frequently,  it  may  be  desirable 
to  introduce  into  the  general  journal  an  additional  column  headed 
"Notes  Receivable,  Dr."  This  will  allow  posting  to  the  debit  of  this 
account  to  be  made  through  the  footing  of  this  column,  rather  than 
by  single  items.  If  the  business  is  such  that  notes  receivable  are 
handled  with  very  great  frequency,  it  becomes  expedient  to  make 
use  of  a  separate  notes  receivable  journal  in  which  to  record  them. 

The  discussion  of  the  special  notes  receivable  journal  will  be 
deferred  to  a  later  point  in  the  course.  For  the  present  it  is  assumed 
that  all  such  transactions  are  recorded  in  the  general  journal.  But 
the  general  journal,  while  it  serves  as  a  medium  through  which  the 
information  may  be  posted  into  the  appropriate  accounts,  is  not  well 
adapted  for  recording  and  classifying  all  the  information  which  should 
be  kept  with  regard  to  notes  receivable.  Any  such  information  desired 
may  be  obtained  by  consulting  the  notes  themselves,  but  it  is  more 
convenient  to  use  a  form  of  supplementary  record  which  may  be  called 
a  notes  receivable  book,  or  notes  receivable  register. 

A  possible  form  of  such  a  subsidiary  record,  indicating  by  its 
column  headings  the  information  for  which  it  makes  provision,  is 
shown  on  page  207. 

What  has  been  said  with  regard  to  the  treatment  of  notes  receiv- 
able applies  equally  well  to  the  treatment  of  notes  payable.  In  only 
a  few  businesses,  however,  do  notes  payable  occur  with  sufficient 
frequency  to  justify  a  special  notes  payable  journal.  As  in  the  case 
of  notes  receivable,  it  is  usually  desirable  to  keep  a  record  of  significant 


BUSINESS  PRACTICE  AND  PROCEDURE 


207 


details  with  regard  to  each  note.    This  may  be  accomplished  by  means 
of  a  supplementary  record  of  a  nature  similar  to  the  one  discussed 

NOTES  RECEIVABLE  REGISTER 


DATE 

NUMBER 

OF 

NOTE 

NAME  OF 

MAKER 
OR  AC- 
CEPTOR 

FACE 
VAL- 
UE 

TIME 
TO  MA- 
TURITY 

INTER- 
EST 
RATE 

AMOUNT 
AT  MA- 
TURITY 

DATE 
OF  MA- 
TURITY 

DATE 
OF  PAY- 
MENT 

DISCOUNTED 

Date 

By 

Amount 

under  notes  receivable.  Such  a  book  would  be  called  a  notes  payable 
book  or  notes  payable  register.  A  possible  form  of  such  a  book, 
showing  provision  for  recording  the  information  which  would  usually 
be  considered  desirable,  is  shown  below: 

NOTES  PAYABLE  REGISTER 


Date 

Number 
-of 
Not* 

Payee 

Face 
Value 

Time 
to 

Maturity 

Interest 
Rate 

Amount 
at 
Maturity 

Date 
of 
Maturity 

Date 
of 
Payment 

Check 
Number 

Use  of  the  trade  acceptance.  Since  the  adoption  of  the  Federal 
Reserve  System  as  the  basis  of  banking  operations  in  the  United 
.States,  a  considerable  amount  of  attention  has  been  given  to  the  use 
of  the  trade  acceptance,  and  a  strong  effort  has  been  made  by  the 
Federal  Reserve  Board  to  induce  business  men  to  make  greater  use 
of  this  form  of  credit.  The  trade  acceptance  is  a  special  form  of 


208 


PRINCIPLES  OF  ACCOUNTING 


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Trade  Acceptance 


BUSINESS  PRACTICE  AND  PROCEDURE  209 

draft,  really  differing  very  little  in  its  essentials  from  forms  of  drafts 
previously  illustrated  and  discussed.  It  is  defined  by  the  Federal 
Reserve  Board  as  "a  bill  of  exchange  drawn  by  the  seller  on  the, 
purchaser  of  goods  sold,  and  accepted  by  such  purchaser." 

The  foregoing  illustration  shows  the  form  of  a  trade  acceptance 
which  has  been  approved  by  the  American  Trade  Acceptance  Council. 
A  comparison  of  this  form  with  the  form  of  accepted  draft  shown  on 
page  167  will  show  that  the  two  are  essentially  the  same.  The  dis- 
tinguishing point  in  connection  with  the  trade  acceptance,  and  the 
one  on  which  the  Federal  Reserve  Board  lays  great  emphasis,  is  that 
this  form  shows  on  its  face  that  it  has  arisen  out  of  an  actual  transfer 
of  goods  from  the  drawer  of  the  draft  to  the  acceptor,  while  the 
ordinary  acceptance  may  arise  out  of  any  sort  of  indebtedness  or 
may  even  represent  a  form  of  loan  by  the  acceptor  to  the  drawer. 
The  fact  that  the  trade  acceptance  is  a  form  of  credit  instrument 
reflecting  an  actual  transfer  of  goods  is  considered  by  the  Federal 
Reserve  Board  to  make  it  a  more  desirable  form  of  commercial  paper 
and  consequently  more  readily  eligible  to  rediscount  by  Federal 
Reserve  banks.  As  a  matter  of  fact,  little  if  any  attention  seems  to 
be  paid  this  feature  by  the  banks.  The  eligibility  of  any  piece  of 
commercial  paper  for  discount  or  rediscount  depends  mainly  on  the 
general  reputation  of  the  firms  responsible  for  its  payment,  and  on  their 
financial  soundness  as  reflected  in  their  accounting  reports. 

An  illustration  will  show  how  the  trade  acceptance  may  be  used. 
Hibbard,  Spencer,  Bartlett  &  Company,  of  Chicago,  sell  the  Central 
Supply  Company,  of  Indianapolis,  merchandise  to  the  amount  of 
$4,000.  The  terms  of  the  sale  are  net  thirty  days,  with  an  agreement 
on  the  part  of  the  Central  Supply  Company  to  accept  a  thirty-day 
draft.  Hibbard,  Spencer,  Bartlett  &  Company  proceed  to  draw  upon 
them  at  thirty  days,  using  the  trade  acceptance  form  of  draft.  They 
send  this  draft  to  the  Central  Supply  Company,  who  accept  and  return 
it.  Hibbard,  Spencer,  Bartlett  &  Company  may  retain  the  draft  and 
coUect  the  amount  of  its  face  at  maturity,  or  they  may  discount  it 
at  their  bank.  In  case  it  is  discounted,  the  Chicago  bank  will  credit 
Hibbard,  Spencer,  Bartlett  &  Company  with  the  face  of  the  draft 
less  the  discount.  The  Chicago  bank  may  hold  it  till  maturity,  at 
which  time  it  will  be  sent  to  their  correspondent  bank  in  Indianapolis 


210  PRINCIPLES  OF  ACCOUNTING 

for  collection,  or,  as  was  suggested  above,  the  Chicago  bank,  if  a 
member  of  the  Federal  Reserve  System,  may  rediscount  such  paper 
with  the  Federal  Reserve  Bank  of  Chicago,  thus  securing  funds  or 
credit  with  that  institution. 

Accounting  for  trade  acceptances.  This  illustration  may  also  be 
used  to  explain  the  accounting  involved  in  connection  with  the  trade 
acceptance.  When  Hibbard,  Spencer,  Bartlett  &  Company  ship  the 
goods  to  the  Central  Supply  Company,  the  entry  on  the  books  of  the 
seller  will  be  a  debit  to  accounts  receivable  and  a  credit  to  sales. 
When  they  receive  the  accepted  draft  the  entry  will  be  debit  to  notes 
receivable  and  a  credit  to  accounts  receivable.  If,  on  the  other  hand, 
they  discount  it  before  maturity,  the  entry  will  be  a  debit  to  cash  for 
the  proceeds,  to  discount  or  interest  for  the  amount  of  the  discount 
deducted  by  the  bank,  and  a  credit  to  notes  receivable  or  notes  receiv- 
able discounted.  In  the  same  way  a  time  draft  drawn  against  a  con- 
cern and  accepted  by  it  is  treated  in  its  accounts  as  notes  payable. 
Thus  trade  acceptances  and  other  accepted  time  drafts  receivable 
and  payable  are  included  in  the  same  accounts  as  notes  receivable 
and  payable,  since  an  accepted  draft  is  legally  of  the  same  import  as  a 
promissory  note. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  The  Wilson  Manufacturing  Company  manufactures  shoes,  which  they 
sell  to  jobbers.    They  sell  for  cash,  on  open  account,  and  for  trade 
acceptances.    How  many  kinds  of  transactions  might  occur  in  such  a 
concern  which  would  result  in  debits  to  cash  ? 

2.  How  many  kinds  of  transactions  can  you  think  of  as  occurring  in  con- 
nection with  the  operations  of  this  business  which  would  result  in  cash 
being  credited  ? 

3.  You  are  being  considered  for  the  position  of  chief  accountant  in  a  large 
retail  store  and  are  asked  to  outline  a  scheme  for  handling  the  cash  in 
that  establishment.    What  questions  would  you  ask  before  giving 
your  answer  ?    Outline  in  general  terms  a  plan  for  handling  cash  which 
you  think  would  apply  in  the  ordinary  business  of  this  nature.     What 
provisions,  if  any,  would  your  plan  make  for  guarding  against  the 

'embezzlement  of  funds  by  members  of  the  organization  ? 

4.  What  do  you  consider  the  most  desirable  form  of  handling  petty  cash 
disbursements  ?    Why  do  you  consider  it  the  most  desirable  plan  ? 


BUSINESS  PRACTICE  AND  PROCEDURE  211 

5.  What  is  the  purpose  of  a  notes  receivable  register?    Under  what 
circumstances  would  you  recommend  its  use  ?  A  notes  payable  register  ? 

6.  Define  a  trade  acceptance.    Describe  its  use,  giving  an  illustration. 
What  are  the  advantages  in  the  use  of  this  form  of  credit?    The 
disadvantages  ? 

7.  Which  do  you  consider  the  more  desirable  form  of  credit,  the  trade 
acceptance  or  the  open  account  ?    Why  ? 

8.  Describe  the  adjustment  which  you  would  make  at  the  end  of  the 
fiscal  period  in  order  to  have  the  petty  cash  agree  with  the  amount 
shown  for  this  item  on  the  balance  sheet. 

9.  Should  you  normally  expect  the  cash  balance-  shown  by  your  records 
to  agree  with  that  shown  by  the  bank's  records  on  the  same  date? 
Why  or  why  not  ?    If  not,  describe  the  procedure  which  you  would 
follow  in  order  to  reconcile  the  two  amounts. 

REFERENCES  FOR  FURTHER  STUDY 

MITCHELL,  T.  W.,  Accounting  Principles,  chap.  xv. 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  xxxv  and 

xxxvii. 
ESQUEREE,  PAUL  JOSEPH,  Applied  Ttieory  of  Accounts,  chaps,  xiii  and  rv. 


CHAPTER  XIX 

BOOKS  OF  ORIGINAL  ENTRY— SALES  AND 
PURCHASES  RECORD 

Purpose  of  books  of  original  entry.  In  chapter  xi  it  was  pointed 
out  that  it  is  inexpedient  to  enter  the  record  of  a  business  transaction 
directly  into  the  ledger  accounts  affected,  and  that  it  is  customary 
to  make  a  preliminary  record  of  the  transaction  as  a  whole,  analyzed 
according  to  the  accounts  affected,  in  some  book  of  original  entry. 
This  preliminary  record  shows  the  debits  and  credits  involved,  and 
serves  as  a  medium  for  posting  them  into  the  ledger.  Besides  this, 
it  may  provide  for  the  recording  of  certain  significant  facts  concerning 
each  transaction,  such  as  could  not  be  conveniently  entered  in  the 
ledger.  It  may  also  have  a  very  important  use  in  facilitating  the 
analysis  of  certain  groups  of  transactions.  This  last  point  will  be 
developed  further  in  the  subsequent  discussion  of  particular  types  of 
such  records.  The  form  which  the  books  of  original  entry  will  assume 
will  vary  with  the  type  of  transaction  which  the  particular  book  is 
intended  to  record,  and  with  the  classification  which  it  seems  desirable 
to  make  of  the  financial  facts  arising  from  such  transactions.  It 
follows  that  there  can  be  no  fixed  form  for  any  book  of  original  entry. 
The  correct  form  in  each  case  is  the  one  which  best  answers  the  purpose 
for  which  it  is  intended. 

Subdivisions  of  the  journal.  Whenever  a  given  type  of  trans- 
actions occurs  in  a  business  with  sufficient  frequency,  it  becomes 
desirable  that  a  special  journal  should  be  devoted  to  that  particular 
class  of  transactions.  Thus  it  is  usual  to  find  a  separate  journal  for 
the  recording  of  each  of  the  following  types  of  transactions:  purchases, 
sales,  cash  receipts,  cash  disbursements.  In  a  business  where  it  is 
the  usual  thing  to  receive  a  considerable  number  of  notes  or  trade 
acceptances  from  customers,  a  special  notes  receivable  journal  would  be 
desirable  as  an  additional  form  of  record.  In  the  same  way,  if  a 
business  frequently  gives  notes  or  trade  acceptances  to  its  creditors, 
a  notes  payable  journal  may  become  worth  while.  Sales  returned  by 


BOOKS  OF  ORIGINAL  ENTRY  213 

customers  and  allowances  made  to  satisfy  claims  of  customers  may 
easily  become  important  enough  to  justify  a  sales  returns  and  allow- 
ances journal,  and  the  same  may  readily  become  true  of  purchase 
returns  and  allowances.  Any  other  type  of  transaction  which  occurs 
frequently  enough  may  call  for  a  special  journal,  for  purposes  of 
analysis  and  for  convenience  in  posting. 

The  use  of  the  general  journal,  and  of  simple  forms  of  the  purchases 
journal,  sales  journal,  and  cash  journals,  has  been  previously  explained. 
Some  of  the  more  complex  forms  of  the  commonly  used  books  of 
original  entry  will  now  be  considered. 

Use  of  special  columns  in  books  of  original  entry.  Probably  the 
most  important  advantage  of  the  use  of  special  journals  is  that  they 
make  possible  the  analysis  of  transactions  into  certain  definite  classes. 
There  have  been  mentioned  in  this  chapter  the  following  classes: 
(i)  purchases,  (2)  sales,  (3)  cash  receipts,  (4)  cash  disbursements, 
(5)  notes  receivable  transactions,  (6)  notes  payable  transactions, 
(7)  sales  returns  and  allowances,  and  (8)  purchase  returns  and  allow- 
ances. Still  other  special  classes  might  be  mentioned,  in  addition  to 
the  remaining  group  of  miscellaneous  transactions.  But  if  a  special 
journal  should  be  devoted  to  each  of  the  types  of  entries  indicated 
and  all  remaining  transactions  entered  in  the  general  journal,  there 
might  well  remain  a  need  for  still  further  classification  within  some  or 
all  of  these  special  groups. 

To  illustrate  this,  the  case  of  cash  receipts  may  be  used.  The 
simple  form  of  cash  journal  shown  in  a  previous  chapter  provides  a 
record  for  all  cash  received.  But  it  may  be  desired  to  classify  cash 
receipts  still  further  with  regard  to  their  sources.  Thus  in  a  retail 
establishment  the  chief  sources  of  cash  receipts  would  be:  (i)  the 
payment  by  customers  of  their  accounts,  (2)  cash  sales,  and  (3)  mis- 
cellaneous receipts,  which  might  include  payment  of  occasional  notes 
receivable,  interest  on  such  notes,  sale  of  fixed  assets,  and  other  items. 

A  classification  of  cash  receipts  along  these  lines  might  be  obtained 
by  having  three  journals  for  cash  receipts,  and  recording  receipts 
from  each  of  the  three  sources  in  a  separate  journal.  This  method 
would  prove  undesirable,  however,  for  the  reason  that  it  is  desirable 
to  keep  in  one  journal  a  record  of  all  cash  receipts,  since  this  facilitates 
the  auditing  of  cash  receipts  and  the  ascertainment  of  the  cash  balance. 
A  satisfactory  solution  to  this  problem  is  to  introduce  into  the  cash 


214 


PRINCIPLES  OF  ACCOUNTING 


receipts  journal  three  special  columns,  recording  the  receipts  from 
each  of  the  three  sources  in  a  separate  column.  The  total  of  each 
column  will  then  indicate  the  total  amount  of  cash  received  from  the 
source  in  question.  In  addition  to  these  three  special  columns,  still 
another  column  would  be  used  to  show  the  total  of  cash  receipts  from 
all  sources.  Assuming  a  retail  business  in  which  customers  are  not 
allowed  any  cash  discounts,  such  a  journal  might  appear  as  follows: 

CASH  RECEIPTS 


Date 

Explanation 

Gen. 
L.F. 

Accts. 
Rec.  F. 

Sundry 
Accts.  Cr. 

Accts. 
Rec.  Cr. 

Sales 
Cr. 

Cash 
Dr. 

May    I 

Balance 

2,420 

50 

2 

Henry     Wilson,     on 

acct. 

5° 

OO 

5° 

00 

2 

Cash  sales  for  day 

90  oo 

90 

00 

3 

Notes  receiv.,  James 

Thompson 

IOO 

OO 

IOO 

00 

3 

Int.    on    notes    rec., 

James  Thompson 

2 

00 

2 

00 

3 

John  Seely,  on  acct. 

35 

00 

35 

00 

3 

Cash  sales  for  day 

no 

00 

no 

00 

The  foregoing  discussion  of  the  cash  receipts  journal  illustrates 
the  principles  involved  in  the  use  of  special  columns  in  the  books  of 
original  entry.  Just  as  the  types  of  transactions  which  occur  most 
frequently  are  taken  out  of  the  general  journal  and  recorded  in  special 
journals,  so  the  subdivisions  within  each  general  type  of  transaction 
may  be  designated  by  the  use  of  special  columns  within  the  special 
journals.  In  the  laboratory  exercises  which  are  given  the  student 
will  have  occasion  to  use  various  special  columns -in  the  books  of 
original  entry,  as  the  nature  of  the  business  transactions  to  be  dealt 
with  becomes  more  varied  and  complicated. 

The  recording  of  sales.  It  is  not  a  matter  of  great  importance 
whether  sales  or  purchases  is  discussed  first.  The  reason  for  taking 
up  sales  first  is  that  in  any  mercantile  business  the  fundamental 
classification  which  will  be  made  of  purchases  and  of  purchase  returns 
and  allowances,  as  well  as  of  sales  returns  and  allowances,  depends  to 
some  extent  on  the  basis  taken  for  the  classification  of  sales.  The 
sales  result  in  the  income  which  makes  it  possible  to  continue  pur- 
chasing goods.  Also  in  a  mercantile  business  merchandise  is  pur- 
chased only  for  the  purpose  of  resale  to  customers,  and  any  plans  for 


BOOKS  OF  ORIGINAL  ENTRY 


215 


future  purchasing  must  be  made  on  the  basis  of  an  estimate  of  future 
sales.  These  facts  make  it  desirable  that  the  actual  sales  for  a  given 
period  and  the  actual  purchases  for  the  same  period"  should  be  classified 
on  a  common  basis. 

A  brief  discussion  cf  the  routine  involved  in  handling  sales  trans- 
actions was  given  in  chapter  xvii,  so  that  the  present  discussion  may 
be  devoted  entirely  to  the  analysis  and  recording  of  such  trans- 
actions. The  analysis  of  a  sales  transaction  into  its  debits  and  credits 
is  very  simple.  In  every  case  value  is  received  by  the  business  in 
some  form,  whether  cash,  notes  receivable,  or  other  forms  of  claim 
against  the  customer.  The  debit  therefore  will  be  to  the  account  or 
accounts  representing  the  form  of  value  which  is  received,  and  the 
credit  to  a  sales  account.  In  a  business  which  sold  only  on  open 
account  and  made  no  attempt  to  classify  the  commodities  sold,  the 
form  of  record  required  would  be  very  simple.  Such  a  sales  journal 
might  appear  as  follows: 

SALES  JOURNAL 


Date 

L.F. 

Account  Debited 

Address 

Terms 

Invoice 
Number 

Amount 

June 

i 

William  Henderson 

Monee,  111. 

2/10/60 

132 

455 

00 

Here  there  is  o'nly  one  form  of  asset  received  and  only  one  sales 
account  to  be  credited,  so  that  a  single  column  is  sufficient.  The 
footing  of  this  column  is  a  debit  to  accounts  receivable  and  a  credit 
to  sales. 

Cash  sales.  If  in  such  a  business  it  became  necessary  to  record 
sales  for  cash  as  well  as  sales  on  account,  it  would  be  possible  to  do  this 
by  means  of  a  sales  column  in  the  cash  receipts  journal,  as  shown  on 
page  214.  The  posting  to  sales  account  could  be  accomplished 
satisfactorily  through  the  footing  of  this  column.  However,  the 
sales  journal  would  no  longer  show  the  total  of  sales,  and  would  also 
fail  to  show  an  analysis  of  sales  according  to  credit  terms,  which  in 
such  a  case  might  well  be  desired.  The  sales  journal  may  be  made  to 
show  the  essential  information  with  regard  to  sales  by  the  introduction 
of  extra  columns  as  follows: 


2l6 


PRINCIPLES  OF  ACCOUNTING 
SALES  JOURNAL 


Date 

Account  Debiftd 

Address 

Terms 

Invoice 
Number 

Accts. 
Rec. 
Dr. 

Cash 
Dr. 

Sales 
Cr. 

June 

I 

Joseph  Lipman 

Keokuk,  Iowa 

2/10/60 

145 

348 

50 

348 

.SO 

2 

Thompson  Bros. 

Hammond,  Ind. 

146 

125 

00 

125 

00 

The  "Cash  Dr."  column  would  not  be  posted,  since  all  cash  received 
must  be  recorded  in  the  cash  receipts  journal,  and  this  debit  is  already 
included  in  the  total  debit  to  cash.  The  cash  column  in  the  sales 
journal  is  there  only  for  purposes  of  analysis.  In  the  same  way  the 
"  Sales  Cr. "  column  hi  the  cash  receipts  journal  would  not  be  posted 
when  this  form  of  sales  journal  is  used,  but  would  be  used  only  as  an 
aid  to  the  analysis  of  cash  receipts. 

Analysis  of  sales  by  departments.  It  will  be  found  that  in  most 
businesses  of  any  considerable  size,  whether  wholesale  or  retail,  the 
commodities  sold  are  assigned  on  some  basis  or  other  to  departments. 
The  management  desires  such  information  as  will  enable  it  to  compare 
results  obtained  hi  the  different  departments,  and  also  such  infor- 
mation as  will  serve  as  a  basis  of  planning  future  business  for  each 
department.  This  means  that  information  concerning  sales,  sales 
deductions,  and  the  cost  of  goods  sold  must  be  analyzed  by  depart- 
ments. Such  an  analysis  of  sales  can  easily  be  provided  in  the  sales 
journal.  Thus,  assuming  a  wholesale  business  with  three  depart- 
ments, which  may  be  called  A,  B,  and  C,  and  assuming  that  this 
concern  sells  goods  on  open  account  and  for  cash,  a  sales  journal 
which  would  provide  the  desired  analysis  might  have  the  following 
form: 

SALES  JOURNAL 


Date 

In- 
voice 

Sold  to 

Address 

Terms 

LJ. 

Accts. 
Rec. 
Dr. 

Cash 
Dr. 

Sales 
Dept. 
A 

Sales 
Dept. 
B 

Sales 
De^t. 

July 

i 

153 

J.  Dole 

Manteno.IH. 

n/30 

400 

00 

I.SO 

00 

100 

00 

15° 

00 

i,S4 

Cent.  Hard- 

ware Co. 

Chicago 

300 

oo 

100 

00 

200 

00 

BOOKS  OF  ORIGINAL  ENTRY 


217 


The  foregoing  illustration  being  for  a  wholesale  business,  each  invoice 
is  entered  as  a  separate  item.  Where  an  invoice  includes  sales  from 
more  than  one  department,  a  separate  sheet  would  usually  be  devoted 
to  the  sales  of  each  department  affected.  This  facilitates  its  analysis 
when  it  is  entered  by  the  accounting  department  in  the  sales  journal. 
Recording  retail  sales.  In  recording  sales  in  a  retail  establishment, 
where  they  are  likely  to  be  much  greater  in  number,  it  is  not  usual  to 
enter  each  sale  as  a  separate  item.  The  sales  tickets  within  each 
department  would  be  collected  at  the  end  of  the  day's  business. 
Cash  sales,  credit  sales,  C.O.D.  sales,  instalment  sales,  etc.,  would 
each  have  a  distinctive  color  of  ticket.  Each  of  these  classes  would 
be  grouped  and  totaled,  and  the  sales  for  the  day  would  then  be 
summarized  and  entered  in  the  sales  journal.  Assuming  a  retail 
business  with  only  three  departments,  such  a  form  of  sales  journal 
might  appear  as  follows: 

SALES  JOURNAL 


DATE 

CASH 

C.O.D. 

ACCOUNTS 
RECEIVABLE 

SALES 
DEPT.  A 

SALES 
DEPT.  B 

SALES 
DEPT.  C" 

TOTAL 

SALES 

City 

Country 

May 

I 

475 

00 

125 

00 

520 

00 

210 

00 

S2S 

00 

410 

00 

395 

00 

1,33° 

00 

In  the  illustration  above  it  is  also  assumed  that  customers'  accounts 
are  divided  into  two  groups,  city  customers  and  out-of-town  customers. 
The  column  for  "Total  Sales"  is  usually  not  posted,  the  credits  being 
ordinarily  made  to  the  -  departmental  sales  accounts  instead.  The 
information  furnished  by  this  "total"  column,  however,  is  usually 
considered  to  be  of  sufficient  interest  to  justify  the  use  of  the  column. 
Sales  deductions.  In  nearly  every  business  the  total  credit  to 
sales,  which  represents  the  total  of  the  invoices  or  sales  tickets  for  the 
particular  department  or  for  the  business  as  a  whole,  is  subject  to  certain 
deductions.  Some  goods  will  be.  returned  as  unsatisfactory.  Allow- 
ances or  rebates  may  have  to  be  given  the  customer  on  account  of  the 
failure  of  goods  sold  to  give  satisfactory  service.  Such  occurrences 
represent  deductions  from  the  item  of  gross  revenue  from  sales,  the 
amount  of  which  revenue  is  shown  by  the  sales  accounts. 


2l8 


PRINCIPLES  OF  ACCOUNTING 


It  would  be  possible  to  ascertain  the  amount  of  net  sales  for  each 
department  by  debiting  any  such  deductions  directly  to  the  sales 
account  to  which  they  belong.  But  the  sales  reports  will  be  much 
more  useful  as  an  aid  to  the  planning  of  future  business  if  such  deduc- 
tions are  shown  separately  instead  of  being  hidden  in  the  sales  accounts. 
Separate  accounts  should  therefore  be  carried  in  the  ledger  for  sales 
deductions,  and  these  accounts  must  provide  the  means  of  classify- 
ing such  deductions  on  the  same  basis  used  for  the  classification  of 
sales.  Sales  returns  and  allowances  are  the  most  common  forms 
of  sales  deductions,  and  will  be  considered  here  for  purposes  of 
illustration. 

Sales  return  and  allowances  journal.  The  nature  of  sales  allow- 
ances really  differs  somewhat  from  that  of  sales  returns,  and  if  the 
former  become  considerable  in  amount,  they  should  be  recorded  as  a 
separate  item-.  It  is  usual,  however,  for  all  deductions  from  these  two 
sources  to  be  carried  in  a  single  account  entitled  "  Sales  Returns  and 
Allowances."  Whatever  classification  is  maintained  for  sales,  the 
same  will  be  required  for  sales  returns  and  allowances.  Thus  if  the 
wholesale  business  whose  sales  journal  was  shown  on  page  216  finds 
that  sales  returns  and  allowances  occur  with  sufficient  frequency  to 
justify  a  separate  journal,  this  journal  would  take  the  following 
form: 

SALES  RETURNS  AND  ALLOWANCES  JOURNAL 


Date 

In- 
voice 
Num- 
ber 

Acct.  Credited 

Address 

L.  F. 

Accts. 
Rec. 
Cr. 

Cash 
Cr. 

R.  and 
A. 
Dept. 
A 

R.and 
A. 
Dept 
B 

R.  and 
A. 
De^t. 

luly 

2 

149 

Thos.  Moran 

Niles,  Mich. 

*5 

00 

55 

00 

5 

153 

J.  Dole 

Manteno,  111. 

40 

00 

15 

00 

25 

00 

A  retail  business  whose  sales  are  classified  on  the  basis  indicated 
in  the  form  of  sales  journal  illustrated  on  page  217  will  probably 
require  a  sales  returns  and  allowances  journal  similar  to  the  following 
form: 


BOOKS  OF  ORIGINAL  ENTRY 
SALES  RETURNS  AND  ALLOWANCES  JOURNAL 


219 


DATE 

CASH 
CR. 

C.O.D. 

ACCOUNTS 
RECEIVABLE 

R.  AND 
A 

DEFT.  A 

R.  AND 

A 

DEFT.  B 

R.  AND 

A 

DEPT.  C 

TOTAL 

R.  AND  A. 

City 

Country 

May 

I 

45 

oo 

3° 

oo 

60 

oo 

125 

OO 

75 

oo 

90 

00 

95 

oo 

260 

oo 

Recording  purchases.  A  consideration  of  purchases  in  the  broad 
meaning  of  the  term  would  include  every  form  of  purchase  made  by 
the  business,  whether  of  salable  merchandise,  raw  materials  for  manu- 
facture, supplies,  or  services  such  as  rent,  labor,  and  the  Like.  It  is 
desirable  to  confine  the  present  discussion  to  the  recording  of  purchases 
of  salable  merchandise.  The  routine  of  such  purchases  has  been 
briefly  considered  in  chapter  xvii,  and  the  form  of  the  record  is  now 
to  be  taken  up. 

In  most  businesses  purchases  of  merchandise  are  generally  made  on 
credit.  The  account  to  be  credited  is  therefore  Accounts  Payable. 
This  is.  so  nearly  the  rule  that  the  typical  business  concern  will  enter 
the  occasional  exception  as  though  it  were  a  purchase  on  account,  and 
then  make  a  second  entry  to  show  the  debit  to  Accounts  Payable  and 
the  credit  to  Cash,  Notes  Payable,  or  whatever  other  account  may  be 
affected. 

The  analysis  of  the  debits  involved  in  a  purchase  transaction  will 
usually  depend  on  the  classification  that  is  made  of  sales  in  that  par- 
ticular business,  since,  as  has  been  previously  pointed  out,  the  accounts 
showing  cost  of  goods  sold  must  correspond  in  classification  to  the 
accounts  with  sales.  In  a  business  which  maintained  no  classification 
of  sales  the  purchases  journal  might  have  the  following  form: 

PURCHASES  JOURNAL 


Date 

L.F. 

Account  Credited 

Address 

Terms 

Invoice 
Number 

Amount 

June 

I 

Wilson  Bros. 

Chicago,  111. 

2/io/n/6o 

45 

457 

50 

220 


PRINCIPLES  OF  ACCOUNTING 


The  footing  of  the  "Amount"  column  is  a  debit  to  purchases  and  a 
credit  to  accounts  payable.  All  purchase  invoices  are  entered  in 
this  journal  and  filed  according  to  whatever  system  is  used  in  the 
business. 

Departmental  analysis  in  the  purchases  journal.  In  a  business 
which  is  organized  into  departments  according  to  the  commodities 
handled,  the  purchases  journal  must  show  the  same  analysis  as  does 
the  sales  journal.  Thus,  assuming  a  business  which  may  be  either 
wholesale  or  retail,  but  with  three  departments,  the  following  form  of 
purchases  journal  may  be  used: 

PURCHASES  JOURNAL 


Date 

L.F. 

Account 
Credited 

Address 

Terms 

Invoice 
No. 

Ac- 
counts 
Pay- 
able 

Pur- 
chases 
Dept. 

Pur- 
chases 
Dept. 

Pur- 
chases 
Dept. 

Tot 
Pui 

Cr. 

A 

B 

C 

June 

i 
6 

Cobb  Mfg.  Co. 
The  Buda  Co. 

St.  Paul     2/10/60 
Chicago     2/10/30 

122 
"3 

675 

450 

oo  675 
oo 

00 

450 

oo 

675 
450 

8 

W.  F.  Hebard 

Co. 

Chicago 

2/10/60 

124 

5*5 

1 

S»5 

00 

S3S 

It  might  be  considered  worth  while  to  introduce  still  other  columns 
into  the  purchases  journal.  Thus  if  the  business  made  a  practice  of 
giving  notes  or  trade  acceptances  in  payment  for  goods,  as  well  as 
purchasing  on  open  account,  an  additional  column  headed  "Notes 
Payable,  Cr."  might  well  be  introduced,  just  to  the  right  of  the 
column  headed  "Accounts  Payable,  Cr."  Or  the  column  headed 
"Terms"  might  be  followed  by  two  columns,  headed  respectively 
"When  Due"  and  "When  Paid."  This  would  make  the  purchases 
record  show  the  date  when  each  invoice  must  be  paid  in  order  to  take 
advantage  of  the  discount  offered,  and  the  date  when  each  was  paid, 
if  it  had  been  paid. 

It  hardly  seems  necessary  to  attempt  to  illustrate  various  possible 
forms  of  the  purchases  journal.  The  foregoing  illustrations  and  dis- 
cussion should  have  furnished  the  student  with  a  working  knowledge 
of  the  principles  involved  in  designing  such  records. 

Purchases  other  than  merchandise.  All  the  forms  of  purchase 
records  just  illustrated  provide  only  for  recording  the  purchase  of 


BOOKS  OF  ORIGINAL  ENTRY 


221 


salable  merchandise.  Other  purchases,  such  as  items  of  equipment, 
supplies,  and  services,  would  be  recorded  in  the  cash  book  if  purchased 
for  cash,  and  when  purchased  on  credit  would  be  recorded  either  in 
the  general  journal  or  in  some  special  journal  designed  for  that  pur- 
pose. It  is  possible  to  have  a  single  purchases  journal  in  which  all 
purchases  on  account  are  recorded.  This  would  necessitate  only  the 
addition  of  other  columns  to  provide  for  debiting  other  than  mer- 
chandise accounts  for  other  types  of  purchases.  The  discussion  of 
such  forms  of  journals  as  would  be  necessitated  by  handling  other 
than  merchandise  purchases  in  the  purchases  journal  is  best  deferred 
to  a  later  point  in  the  study  of  accounting. 

Purchase  deductions.  In  connection  with  purchases,  as  with  sales, 
there  are  certain  deductions  to  be  considered.  An  analysis  of  these 
deductions  must  be  maintained  along  the  same  lines  on  which  sales 
and  purchases  are  analyzed.  The  classification  of  purchase  returns 
and  allowances,  therefore,  will  be  similar  to  that  of  the  merchandise 
purchases,  and  the  form  of  journal  used  to  record  them  will  be  deter- 
mined by  the  form  of  the  purchases  journal.  A  single  illustration 
should  serve  to  make  this  matter  clear.  Taking  the  form  of  purchases 
journal  shown  on  page  220,  the  purchase  returns  and  allowances 
journal  which  would  be  used  to  correspond  to  the  analysis  shown 
there  would  appear  as  follows: 

PURCHASE  RETURNS  AND  ALLOWANCES  JOURNAL 


Date 

L.F. 

Account  Debited 

Address 

Invoice 
Number 

Accounts 
Payable 
Dr. 

R.and 
A. 
Dept.  A 

R.  and 
A. 
Dept.  B 

R.  and 
A. 
Dept.  C 

Jan. 

4 

Cobb  Mfg.  Co. 

St.  Paul 

122 

5° 

00 

50 

00 

This  form  of  journal  should  serve  to  indicate  the  necessary  cor- 
respondence between  the  analysis  of  purchases  and  that  of  purchase 
deductions,  and  the  student  should  not  meet  with  any  appreciable 
difficulty  in  designing  a  purchase  returns  and  allowances  journal  after 
he  has  once  determined  upon  the  form  to  be  used  for  the  purchases 
journal. 


222  PRINCIPLES  OF  ACCOUNTING 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  What  purposes  are  served  by  the  books  of  original  entry? 

2.  You  are  asked  to  design  an  accounting  system  for  the  J.  B.  Saunders 
Company,  a  wholesale  hardware  business.     What  information  should 
you  obtain  before  determining  what  books  of  original  entry  to  use  ? 

3.  From  your  present  general  knowledge  of  the  nature  of  the  wholesale 
hardware  business,  what  books  of  original  entry  do  you  think  you  might 
use  for  recording  the  transactions  of  such  a  business  ? 

4.  What  purposes  are  served  by  the  use  of  special  columns  in  the  books  of 
original  entry  ? 

5.  Assume  that  the  J.  B.  Saunders  Company  is  organized  with  four 
departments,  which  may  be  indicated  as  Departments  A,  B,  C,  and  D, 
and  that  sales  are  made  on  open  account  and  for  trade  acceptances. 
List  the  columns  which  you  would  use  in  the  sales  journal  which  you 
would  design  for  this  business;  in  the  sales  returns  and  allowances 
journal. 

6.  What  columns  would  you  suggest  for  the  sales  journal  of  the  F.  C.  Miller 
Company,  a  retail  clothing  business  with  four  departments,  which  sells 
for  cash  and  on  monthly  account  ?    Describe  the  routine  which  would 
be  followed  in  making  entries  in  this  journal. 

7.  List  the  columns  which  would  be  needed  in  the^ales  returns  and  allow- 
ances journal  of  the  Miller  Company,  and  describe  the  routine  which 
would  be  followed  in  connection  with  entries  of  this  type. 

8.  What  differences,  if  any,  would  you  make  between  the  form  of  purchases 
journal  to  be  used  for  the  Saunders  Company  and  that  used  by  the 
Miller  Company  ?    List  the  columns  which  you  would  use  for  each  of 
them. 

9.  List  the  columns  which  you  would  use  in  the  purchase  returns  and 
allowances  journal  of  each  of  these  businesses. 

10.  In  view  of  the  recommendations  which  you  have  made  for  the  pur- 
chases, sales,  purchase  returns  and  allowances,  and  sales  returns  and 
allowances  journals  of  the  Saunders  Company,  list  the  trading  accounts 
which  would  be  maintained  in  the  ledger  of  that  business. 

n.  What  difference,  if  any,  would  there  be  in  the  trading  accounts  of  the 
two  businesses? 

REFERENCES  FOR  FURTHER  STUDY 

ESQUERRE,  PAUL- JOSEPH,  Applied  Theory  of  Accounts,  chap.  viii. 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap,  xxxix. 
MITCHELL,  T.  W.,  Accounting  Principles,  chap.  vii. 


CHAPTER  XX 

BOOKS  OF  ORIGINAL  ENTRY— THE 
CASH  JOURNAL 

The  cash  book.  The  nature  of  the  record  that  must  be  kept  with 
cash  receipts  and  cash  disbursements  was  explained  in  chapter  xii, 
where  certain  very  simple  forms  of  records  with  cash  were  suggested. 
It  was  there  explained  that  the  two  journals,  one  for  receipts  and  the 
other  for  disbursements,  together  constitute  what  is  known  as  the 
casti  book.  By  comparing  the  total  debits  to  cash  on  the  one  side  with 
the  total  credits  to  cash  on  the  other  side,  it  is  possible  at  any  time  to 
ascertain  the  balance  of  available  cash.  In  the  preceding  chapter  the 
desirability  of  maintaining  an  analysis  of  cash  receipts  and  of  cash 
disbursements  was  indicated,  and  the  use  of  special  columns  in  the 
cash  journals  for  this  purpose  was  illustrated.  In  the  present  chapter 
the  possibilities  of  such  analysis  will  be  considered  further,  as  applied 
to  both  receipts  and  disbursements,  and  the  use  of  special  columns 
for  this  purpose  will  be  given  further  discussion. 

In  chapter  xviii  the  business  procedure  and  routine  involved  hi  the 
handling  of  cash  transactions  was  discussed.  A  knowledge  of  the 
subject-matter  of  that  chapter  will  therefore  be  assumed  at  this  point, 
and  the  present  discussion  confined  to  the  matter  of  recording  these 
transactions. 

Cash  receipts — analysis.  In  recording  transactions  involving  cash 
receipts  it  might  seem  that  the  cash  account  is  the  only  one  to  be 
debited.  Further  consideration,  however,  reveals  the  fact  that  the 
receipt  of  cash  may  involve  a  debit  to  some  other  account,  along  with 
a  debit  to  Cash.  The  most  common  instance  of  this  is  in  the  case  of 
cash  discount  on  sales,  which  occurs  regularly  in  wholesale  businesses, 
and  in  certain  departments  of  some  retail  businesses.  Thus  in  selling 
goods  at  wholesale,  they  are  usually  invoiced  to  the  customer  at  a 
certain  price,  payable  within  a  fixed  time  (usually  thirty  or  sixty  days), 
but  subject  to  discount  if  paid  within  a  shorter  period,  generally  ten 
days  from  the  date  of  the  invoice.  In  such  a  case,  when  the  customer 

223 


224  PRINCIPLES  OF  ACCOUNTING 

remits  within  ten  days,  the  amount  of  the  check  will  be  the  total  of 
the  invoice  less  the  discount  allowed.  In  recording  the  receipt  of 
such  a  remittance,  the  customer  must  be  dedited  with  the  amount 
of  the  invoice,  while  Cash  can  be  debited  only  for  the  amount  of  the 
check.  The  difference  is  a  debit  to  Cash  Discount  on  Sales.  It  will 
therefore  be  necessary  to  have  a  special  column  introduced  into  the 
cash  receipts  journal  to  provide  for  debits  to  this  account. 

The  nature  of  the  account  with  cash  discount  on  sales,  and  its 
treatment  in  the  reports,  will  be  discussed  in  a  later  chapter. 

A  somewhat  similar  case  occurs  when  a  note  is  discounted  at  the 
bank.  Assuming  that  a  business  borrows  at  the  bank,  giving  its 
own  note  for  $1,000,  due  in  sixty  days,  without  interest,  and  that 
the  discount  rate  is  6  per  cent,  the  journalization  of  the  transaction 
involves  a  credit  to  Notes  Payable  for  $1,000,  a  debit  to  Cash  for  $990, 
and  $10  debit  to  Interest  on  Notes  Payable.  This  type  of  transaction 
is  much  less  frequent  than  that  involving  cash  discount  on  sales, 
but  must  be  provided  for  in  some  manner  in  the  books  of  original 
entry.  It  is  possible  to  divide  the  transaction  into  two  parts,  with  an 
entry  in  the  cash  receipts  journal  debiting  Cash  for  $990  and  crediting 
Notes  Payable  for  the  same  amount,  and  to  make  another  entry  in  the 
general  journal,  debiting  Interest  on  Notes  Payable  for  $10  and  credit- 
ing Notes  Payable.  Such  a  transaction  may  be  recorded  in  the  cash 
book  by  an  entry  in  the  cash  receipts  journal  debiting  Cash  for  $1,000 
and  crediting  Notes  Payable  for  that  amount,  with  another  entry  in 
the  cash  disbursements  journal  debiting  Interest  and  crediting  Cash 
for  $10,  the  amount  of  the  interest.  Or  it  may  all  be  recorded  in  the 
cash  receipts  journal  by  having  a  special  column  for  .debits  to  Interest. 
Such  a  column  would  be  hardly  worth  while  if  transactions  of  this 
type  are  very  infrequent. 

Cash  receipts — credits.  The  analysis  of  cash  receipts  according 
to  their  sources  may  involve  several  accounts,  although  not  so  great 
a  number  as  will  usually  be  involved  hi  an  analysis  of  the  cash  dis- 
bursements. Some  idea  of  the  accounts  that  may  be  credited  when 
cash  is  received  may  be  gained  from  a  consideration  of  the  sources 
from  which  cash  may  be  received.  These  may  be  listed  as  follows: 
(i)  receipts  from  cash  sales;  (2)  receipts  from  customers  in  payment 
of  open  accounts;  (3)  receipts  in  payment  of  notes  receivable; 


BOOKS  OF  ORIGINAL  ENTRY  225 

(4)  receipts  from  discounting  notes  receivable  at  the  bank;  (5)  re- 
ceipts from  additional  investment  in  the  business  by  the  owners  (sole 
proprietor,  partners,  or  stockholders);  (6)  receipts  from  interest  on 
notes  receivable  or  on  bank  balances;  (7)  receipts  from  borrowing 
on  short-time  notes  payable  (from  the  bank) ;  (8)  receipts  from  borrow- 
ing on  long-time  obligations;  (9)  receipts  from  the  sale  of  fixed  assets; 
(10)  receipts  from  the  income  on  long-time  investments  held  by  the 
business;  (n)  miscellaneous  (sales  of  waste,  rentals  of  equipment, 

etc.). 

An  examination  of  this  list  of  possible  sources  of  receipts  shows 
that  there  may  be  a  number  of  accounts  to  be  credited  for  cash 
receipts.  But  it  is  also  apparent  that  only  a  few  of  these  accounts  will 
be  credited  with  any  considerable  degree  of  frequency.  In  planning 
the  form  to  be  used  for  the  cash  receipts  journal,  then,  special  col- 
umns should  be  provided  to  take  care  of  the  credits  to  those  accounts 
which  occur  with  the  greatest  frequency,  leaving  the  credits  to  ac- 
counts which  occur  less  often  to  be  entered  in  the  general  credit 
column,  which  may  be  headed  "Sundry  Accounts,  Cr."  Credits 
entered  in  this  column  could  not  be  posted  through  the  footing  of  the 
column,  but  would  be  posted  item  by  item  to  the  credit  of  the  proper 
accounts.  In  making  a  complete  analysis  of  cash  receipts  for  a  given 
period,  it  would  be  necessary  to  prepare  a  separate  schedule  showing 
further  analysis  of  the  terms  entered  in  this  general  column,  in  such 
detail  as  might  be  considered  desirable.  The  information  shown  by 
this  schedule  would  then  be  embodied  in  the  general  analysis  of  total 
cash  receipts. 

Illustration  of  cash  receipts  journal.  In  the  preceding  chapter  a 
simple  form  of  cash  receipts  journal  was  shown,  illustrating  the  use  of 
special  columns.  The  form  that  will  prove  desirable  hi  any  particular 
business  depends  on  the  accounts  that  are  affected  by  cash  receipts, 
and  the  frequency  with  which  cash  receipts  from  each  particular 
source  occur.  The  form  of  cash  receipts  journal  which  appears  below 
provides  special  columns  for  the  analysis  of  receipts  according  to  the 
more  usual  sources.  All  other  credits  are  entered  in  a  general  column 
and  posted  item  by  item  to  the  ledger  account.  If  further  analysis  of 
receipts  is  desired  for  any  purpose,  it  may  be  obtained  by  making  a 
recapitulation  of  this  general  column. 


226 


PRINCIPLES  OF  ACCOUNTING 


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BOOKS  OF  ORIGINAL  ENTRY  227 

It  should  not  be  Difficult  for  the  student  to  understand  the  purpose  of 
the  money  columns  in  the  form  of  journal  shown  on  page  226.  It  is 
probable,  however,  that  he  will  not  fully  understand  the  process  of 
posting  or  the  use  in  this  connection  of  the  two  folio  columns.  These 
points  may  well  be  passed  over  for  the  purpose  of  the  present  chapter. 
They  will  be  fully  explained  and  illustrated  in  the  next  chapter.  For 
the  present  it  is  enough  if  the  student  understands  how  the  forms  here 
shown  are  used  for  purpose  of  analysis. 

Analysis  of  cash  disbursements — credits.  Every  entry  made  in  the 
cash  disbursements  journal  is  supposed  to  involve  a  credit  to  cash, 
and  actually  does  involve  such  a  credit.  But  one  type  of  cash  dis- 
bursement also  involves  credits  to  another  account  as  well.  This  is 
the  account  with  cash  discount  on  purchases.  The  nature  of  the 
transactions  which  result  in  a  debit  to  Cash  Discount  on  Sales  was 
explained  in  the  discussion  of  the  recording  of  cash  receipts.  From 
the  point  of  view  of  the  individual  or  firm  who  pays  for  the  goods"and 
takes  the  discount,  this  is  cash  discount  on  purchases.  Thus  when  we 
pay  an  invoice  upon  which  a  cash  discount  is  allowed,  remitting 
within  the  time  limit  and  deducting  the  discount,  the  entry  is  a  debit 
to  Accounts  Payable  for  the  amount  of  the  invoice,  a  credit  to  Cash 
for  the  amount  of  the  check,  and  a  credit  to  Cash  Discount  on  Pur- 
chases for  the  amount  deducted.  The  cash  disbursements  journal, 
therefore,  will  usually  provide  two  credit  columns — one  for  Cash,  and 
the  other  for  Cash  Discount  on  Purchases. 

Analysis  of  cash  disbursements — debits.  Cash  disbursements  may 
involve  debits  to  a  number  of  different  accounts,  since  expenditures 
of  cash  may  be  chargeable  to  practically  any  expense  account  or  asset 
account  in  the  ledger.  The  greater  number  of  these  accounts  will  not 
be  affected  very  frequently,  however,  and  there  are  usually  a  very 
few  accounts  which  are  charged  through  the  cash  disbursements 
journal  often  enough  to  justify  carrying  special  columns  for  them. 
The  nature  of  the  business  and  the  frequency  with  which  certain 
accounts  are  affected  by  cash  disbursements  will  determine  what 
special  columns  should  be  used  in  this  journal.  The  one  which 
usually  occurs  with  the  greatest  regularity  is  Accounts  Payable.  This 
account  will  practically  always  require  a  special  column.  It  is  not 
usual  for  any  entry  affecting  purchases  accoimt  to  be  made  in  the 


228 


PRINCIPLES  OF  ACCOUNTING 


cash  book,  since  purchases  are  generally  classified  in  the  purchases 
journal  and  therefore  entered  in  that  book  and  posted  from  it.  Cash 
purchases  of  merchandise  are  very  rare  in  most  businesses,  and  where 
they  do  occur  are  usually  entered  as  purchases  on  account,  accounts 
payable  being  credited  through  the  purchases  journal.  The  payment 
is  then  recorded  in  the  cash  disbursements  journal  as  a  credit  to  Cash 
and  a  debit  to  Accounts  Payable. 

If  the  business  makes  a  practice  of  giving  notes  payable  td  trade 
creditors,  so  that  such  notes  occur  rather  frequently,  a  special  column 
for  recording  them  may  be  provided  in  the  cash  disbursements  journal. 
It  may  be  said,  however,  that  there  are  not  very  many  businesses 
where  the  notes  payable  are  numerous  enough  to  justify  this.  Other 
special  columns  may  be  provided  for  debits  to  any  expense  accounts 
which  are  affected  frequently  enough  to  make  such  columns  worth 
while.  The  debits  for  which  no  special  columns  are  provided  will  be 
entered  in  a  general  column,  which  is  usually  headed  "Sundry 
Accounts,  Dr."  or  with  some  similar  caption,  and  these  debits  will  be 
posted  to  the  ledger,  item  by  item.  A  complete  analysis  of  cash  dis- 
bursements would  require  that  a  recapitulation  be  made  of  the  items 
in  this  general  column. 

Illustrations  of  the  cash  disbursements  journal.  It  has  been 
explained  that  the  recording  of  cash  requires  the  use  of  two  journals, 
one  for  receipts  and  one  for  disbursements,  and  that  the  two  together 
constitute  the  cash  book.  The  amount  of  analysis  provided  for  in 
each  of  these  journals  will  depend  on  the  size  and  complexity  of  the 
business.  A  very  simple  form  of  cash  book  for  a  small  wholesale 
business  which  takes  discounts  on  purchases  and  allows  discounts 
on  sales  might  make  use  of  the  following  columns:  , 

CASH  RECEIPTS 


Accounts 

Sales 

Date 

L.F. 

Account  Credited 

Explanation 

Receiv- 

Discount 

Cash  Dr. 

able  Cr. 

Dr. 

Jan. 

I 

Balance 

On  hand 

2,500 

00 

2 

J.  Henry 

Invoice  No.  43 

200 

00 

4 

oo 

196 

00 

BOOKS  OF  ORIGINAL  ENTRY 
CASH  DISBURSEMENTS 


229 


Accounts 

Purchases 

Date 

L.F. 

Account  Debited 

Explanation 

Payable 

Discount 

Cash  Cr 

Dr. 

Cr. 

Jan. 

2 

Rent 

For  January 

100 

00 

3 

James  Bros. 

Invoice  No.  23 

500 

00 

10 

00 

490 

00 

The  relation  between  the  two  sides  of  the  cash  book,  which  is  most 
apparent  when  it  has  been  balanced  and  ruled  up  at  the  end  of  the 
period,  is  not  clearly  shown  in  the  foregoing  illustration.  For  a  better 
illustration  of  this  relationship,  the  student  is  referred  to  page  245 
in  the  following  chapter. 

A  cash  book  for  a  somewhat  larger  business,  providing  more 
analysis  than  the  form  just  shown,  might  combine  the  form  of  cash 
receipts  journal  shown  on  page  214  with  the  form  of  cash  disbursements 
journal  shown  below: 

CASH  DISBURSEMENTS 


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Light  bill  for  January 

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00 

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Jones   and  Co.,  In- 

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600 

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12 

00 

588 

00 

The  illustrations  offered  in  this  chapter1  give  the  student  a  view  of 
the  ways  in  which  the  cash  book  may  be  used  for  purposes  of  analysis. 

1  It  is  not  considered  worth  while  to  illustrate  forms  of  notes  journals  at  this 
point.  The  laboratory  work  for  this  elementary  presentation  does  not  involve 
the  use  of  such  journals,  and  the  ordinary  business  is  not  likely  to  find  it  worth 
while  to  use  them. 


230  PRINCIPLES  OF  ACCOUNTING 

In  the  following  chapter  a  somewhat  fuller  discussion  is  given  of  the 
manner  in  which  transactions  are  to  be  entered  in  such  a  record,  and 
the  manner  of  posting  from  them  to  the  ledger  accounts. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  What  accounts  besides  cash  may  be  debited  as  a  result  of  transactions 
involving  cash  receipts  ?    What  methods  may  be  employed  in  entering 
such  debits  in  the  books  of  original  entry  ?    What  will  determine  the 
relative  desirability  of  these  methods  in  a  given  case? 

2.  What  accounts  besides  cash  may  be  credited  as  a  result  of  transactions 
involving  cash  disbursements?    What  methods  may  be  employed  for 
the  entry  of  such  credits  ?    What  will  determine  the  relative  desirability 
of  these  methods  in  a  given  case  ? 

3.  The  J.  B.  Saunders  Company,  mentioned  in  the  questions  at  the  end 
of  the  preceding  chapter,  sells  goods  on  open  account,  all  such  accounts 
being  payable  in  sixty  days,  and  allows  its  customers  to  deduct  a  2  per 
cent  discount  if  the  invoice  is  paid  for  within  ten  days.    It  occasionally 
borrows  money  from  the  bank  on  its  notes,  and  sometimes  obtains 
funds  from  the  bank  by  discounting  the  notes  of  its  customers.    List 
all  the  sources  from  which  you  think  this  company  might  receive  cash. 
Which  of  these  sources  of  cash  receipts  do  you  think  would  require 
special  columns  in  the  cash  receipts  journal  ? 

4.  The  F.  C.  Miller  Company,  also  mentioned  in  the  questions  at  the  end 
of  the  preceding  chapter,  does  not  allow  cash  discounts  to  customers, 
and  does  not  make  a  practice  of  taking  the  notes  of  customers.    List 
as  many  possible  sources  of  cash  receipts  as  you  can  think  of  for  this 
business.    Which  of  these  would  require  special  columns  in  the  cash 
receipts  journal  ? 

5.  Making  any  assumptions  you  may  consider  necessary  and  stating  what 
assumptions  you  do  make,  design  a  cash  book  which  you  think  would 
serve  for  the  use  of  the  J.  B.  Saunders  Company. 

6.  Follow  the  same  instructions  and  design  a  cash  book  for  the  F.  C. 
Miller  Company. 

7.  Comment  on  any  differences  in  the  forms  prepared  under  Questions 
5  and  6.     Give  reasons  for  such  differences. 

REFERENCES  FOR  FURTHER  STUDY 

ESQUERRE,  PAUL- JOSEPH,  Applied  Theory  of  Accounts,  chaps,  viii  and  xiii. 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xxi. 


BOOKS  OF  ORIGINAL  ENTRY  231 

LABORATORY  EXERCISE  NO.  32 

W.  C.  Harvey  has  decided  to  go  into  the  retail  hardware  business.  He 
engages  you  to  instal  a  suitable  system  of  accounting  for  his  business,  to 
oversee  the  daily  work  of  the  bookkeeper  until  you  are  sure  that  the  latter 
understands  the  use  of  the  accounts,  and  to  prepare  reports  monthly  until 
you  are  satisfied  that  these  can  be  prepared*  properly  by  the  bookkeeper. 
After  some  discussion  of  Mr.  Harvey's  plans  for  the  business,  you  have 
drawn  up  the  following  as  a  tentative  outline  of  the  accounts  that  will  be 
needed  for  the  preparation  of  the  accounting  reports. 

1.  Asset  accounts 

11.  Current  asset  accounts 
in.  Cash 

112.  Accounts  Receivable  (individual  accounts) 

113.  Notes  Receivable 

1103.  Reserve  for  Bad  Debts' 

114.  Merchandise  Inventory 

115.  Accrued  Interest  Receivable 

12.  Deferred  charges  accounts 

121.  Prepaid  Insurance 

122.  Other  Prepaid  Expense 

13.  Fixed  assets  accounts 

131.  Delivery  Equipment 

1301.  Reserve  for  Depreciation  of  Delivery  Equipment 

132.  Store  and  Office  Equipment 

1302.  Reserve  for  Depreciation  of  Store  and  Office  Equipment 

2.  Liability  accounts 

21.  Current  liability  accounts 

211.  Accounts  Payable  (individual  accounts) 

212.  Notes  Payable — Trade  Creditors 

213.  Notes  Payable — Banks 

214.  Expense  Accrued 

3.  Proprietorship  accounts 

31.  W.  C.  Harvey,  Capital 

32.  W.  C.  Harvey,  Personal 

1  To  indicate  that  certain  accounts  are  of  an  opposite  nature  to  those  with 
which  they  are  included,  and  are  to  be  considered  "valuation"  or  deduction 
accounts,  a  cipher  is  introduced  before  the  final  integer  in  the  number  indicating 
such  an  account. 


232  PRINCIPLES  OF  ACCOUNTING 

4.  Income  accounts 

41.  Operating  income  accounts 
411.  Merchandise  Sales 

4101.  Sales  Returns  and  Allowances 

42.  Other  income  accounts 

421.  Interest  on  Notes  Receivable 

422.  Cash  Discount  on  Purchases 

5.  Expense  accounts 

51.  Operating  expense  accounts 

511.  Purchases 

5101.    Purchase  Returns  and  Allowances 

512.  Selling  expense  accounts 

5121.  Sales  Salaries 

5122.  Advertising 

5123.  Delivery  Expense 

5124.  Other  Selling  Expense 

513.  General  and  administrative  expense  accounts 

5131.  Rent 

5132.  Heat  and  Light 

5133.  Office  Salaries 

5134.  Insurance  and  Taxes 

5135.  Other  Office  Expense 

52.  Other  deductions  from  income 
521.  Interest  on  Notes  Payable. 

For  the  present,  books  of  original  entry  to  be  used  are  (i)  a  journal, 
(2)  a  cash  book,  (3)  a  purchases  journal,  and  (4)  a  sales  journal.  (For  the 
forms  of  these  books  see  illustrations  in  the  chapter  on  the  use  of  special 
columns  in  books  of  original  entry.)  All  cash  transactions  are  to  be  entered 
in  the  cash  book.  All  sales  on  account  are  to  be  entered  in  the  sales  journal. 
All  purchases  of  merchandise  on  account  are  to  be  entered  in  the  purchases 
journal.  Other  purchases  on  account  are  to  be  entered  in  the  journal.  It 
is  anticipated  that  some  sales  may  be  made  of  farm  equipment  for  which 
notes  will  be  taken.  In  such  cases  the  procedure  will  be  to  record  the  sale 
in  the  sales  journal  as  a  sale  on  account,  and  then  to  record  the  receipt  of  the 
note  in  the  journal  as  a  separate  transaction,  debiting  notes  receivable  and 
crediting  the  customer.  Unless  otherwise  specified  in  the  description  of  the 
transaction,  sales  and  purchases  are  assumed  to  be  made  on  account. 

For  the  purchases  journal  and  the  sales  journal,  journal  ruled  paper 
may  be  used.  For  the  cash  book,  however,  the  special  columnar  journal 
form  will  be  required. 


BOOKS  OF  ORIGINAL  ENTRY  233 

In  this  exercise  controlling  accounts  (explained  in  chapter  xxi)  will  be 
carried  in  the  ledger  for  accounts  receivable  and  accounts  payable.  The 
accounts  with  individual  customers  and  creditors  should  be  carried  on 
separate  sheets  of  ledger  paper,  representing  the  customers'  ledger  and 
creditors'  ledger.  These  accounts  may  be  carried  three  to  the  page.  The 
general  ledger  accounts  may  be  carried  two  to  the  page. 

It  is  desirable  that  the  accounts  with  individual  customers  and  creditors 
should  be  kept  posted  up  to  date  day  by  day,  since  the  proper  entry  for 
some  of  the  transactions  will  require  a  knowledge  of  the  standing  of  certain 
individual  accounts  in  these  ledgers. 

TRANSACTIONS  FOR  APRIL 

April  i 

W.  C.  Harvey  enters  the  retail  hardware  business,  investing  cash, 
$6,000.00.  He  rents  a  store  building  for  $125.00  a  month,  paying  the  first 
month's  rent  in  advance.  He  purchases  a  ladder,  scales,  and  other  equip- 
ment necessary  for  the  store,  amounting  to  $250.00,  and  gives  his  check 
for  the  amount. 

April  2 

Buys  of  Western  Supply  Co.  a  typewriter,  table  desk,  and  office  chairs, 
for  $175.00,  terms  net  cash  in  fifteen  days.  Pays  cash  for  stationery, 
stamps,  and  other  office  supplies,  $50.00.  Receives  invoice  of  hardware 
from  the  W.  D.  Allen  Co.,  amount  $5,000.00,  terms  2/io/n/6o.  Cash 
sales  for  the  day,  $53.65. 

April  3 

Pays  insurance  premium  on  stock  for  one  year,  $36.00.  Sells  Peter 
Henderson  a  stove,  $50.00,  on  account.  Sells  Adam  Jones  builders'  sup- 
plies, $75.00,  on  account.  Cash  sales,  $45.00. 

April  4 

Buys  for  cash  a  used  Ford  truck  for  hauling  and  for  making  deliveries, 
$350.00.  Receives  invoice  of  shipment  from  Barrett-Christie  Hardware 
Co.,  Chicago,  $175.00,  2/io/n/6o.  Sells  Andrew  Anderson  on  account, 
$45.00.  Sells  Jacob  Gunderson  builders'  hardware,  $160.00,  on  account. 
Cash  sales,  $68.00. 

April  5 

Pays  for  repairing  car  and  for  gasoline  and  supplies,  $45.00.  Sells 
Charles  Robinson  on  account,  $35.00.  Pays  postage,  $20.00.  Cash  sales, 
$58.00. 


234  PRINCIPLES  OF  ACCOUNTING 

April  6 

Pays  bookkeeper,  $20.00;  clerk,  $25.00;  driver,  $25.00.  Withdraws 
for  personal  use,  $35.00. 

AprilS 

Buys  five  tons  of  coal,  $55.00,  paying  cash.  Sells  William  Gibson 
$48.00,  on  account.  Cash  sales,  $62.50. 

April  p 

Sells  Jacob  Gunderson  $42.00,  on  account.  Adam  Jones  pays  for  goods 
sold  him  on  April  3.'  Cash  sales,  $71.00. 

April  10 

Sells  James  Freeman  builders'  hardware,  $200.00,  taking  his  sixty-day 
note  with  interest  at  6  per  cent  in  payment.  Borrows  $2,000.00  from  the 
Merchants  Bank,  on  a  ninety-day  note,  with  interest  at  6  per  cent.  Cash 
sales,  $68.00.  , 

April  ii 

Pays  W.  D.  Allen  Company's  invoice  of  April  2,  less  discount. 
Receives  invoice  for  shipment  of  merchandise  from  the  Moline  Manufactur- 
ing Co.,  $450.00,  terms  2/10/11/30.  Cash  sales,  $65.00. 

April  12 

Sells  William  Gibson  $70.00  on  account.  Receives  invoice,  W.  D. 
Allen  Co.,  $500.00,  2/io/n/3o.  Pays  for  office  supplies,  $15.00.  Cash 
sales,  $74.00. 

April  13 

Pays  the  Barrett-Christie  Company's  invoice  of  April  4,  less  discount. 
Pays  salaries  the  same  as  last  week's.  Withdraws  $50.00  for  personal  use. 
Sells  Adam  Jones  $57.50  on  account.  Cash  sales,  $65.00. 

April  15 

Pays  Western  Supply  Company's  invoice  of  April  2,  net.  Cash  sales, 
$60.00. 

April  16 

Receives  and  pays  a  bill  from  the  garage  where  the  car  is  kept,  for 
$30.00.  Purchases  a  lot  of  hardware  at  a  bankrupt  sale,  giving  his  check 
for  the  amount,  $750.00.  Returns  to  Moline  Manufacturing  Co.  goods 
which  cost  $35.00,  receiving  credit  for  that  amount.  Cash  sales,  $58.00. 

April  17 

William  Gibson  returns  as  unsatisfactory  goods  purchased  on  April  8, 
to  the  amount  of  $7.50.  He  is  given  credit  for  that  amount,  and  pays  the 


BOOKS  OF  ORIGINAL  ENTRY  235 

balance  of  his  bill  for  that  date.  Receives  an  invoice  from  the  Simmons 
Hardware  Co.,  St.  Louis,  Mo.,  $750.00,  2/10/11/30.  Pays  freight  on  this 
shipment,  $30.00. 

Aprtt  18 

Sells  Herman  Rowe,  Morgan  Park,  Illinois,  builders'  hardware,  $180.00 
on  account,  f.o.b.  his  station'.  Pays  freight  on  same,  $2.50.  Cash 
sales,  $67.50. 

April  19 

Sells  Andrew  Anderson  $75.00  on  account.  Jacob  Gunderson  pays  his 
bill  of  April  9.  Cash  sales,  $77.50. 

April  20 

Pays  salaries  for  the  week,  with  addition  of  $15.00  to  a  boy  for  general 
office  and  errand  work.  Pays  Moline  Manufacturing  Co.'s  invoice  of 
April  ii,  less  discount.  Cash  sales,  $75.00.  Henceforth  cash  sales  will  be 
reported  as  weekly  totals. 

April  22 

Withdraws  for  personal  use,  $50.00.  Pays  W.  D.  Allen  Co.'s  invoice 
of  April  12,  less  discount. 

April  23 

Andrew  Anderson  is  allowed  credit  of  $15.00  for  merchandise  which 
proved  defective.  He  pays  his  account  to  date. 

April  24 

Sells  Herfry  Greiner,  Monee,  Illinois,  builders'  hardware  to  the  amount 
of  $200.00.  We  prepay  the  freight,  $4.50,  and  add  it  to  the  amount  of  the 
invoice,  charging  his  account  with  the  total. 

April  25 

Purchases  a  clock  for  the  office,  $i  5.00.  Sells  Herman  Rowe  on  account, 
$50.00.  Discounts  own  note  at  bank,  $500.00  for  thirty,  days,  discounted 
at  6  per  cent. 

April  26 

Pays  $10.00  for  repairs  on  store  furniture.  Pays  $7.50  for  materials 
used  in  decorating  the  show  windows.  Receives  invoice  from  Hibbard, 
Spencer,  and  Bartlett,  for  $400.00,  2/20/0/30.  Sells  Jacob  Gunderson 
$65.00  on  account. 

April  27 

Sells  William  Gibson  $75.00  on  account.  Pays  salaries,  same  as  last 
week.  Withdraws  $50.00  for  personal  use.  Pays  Simmons  Hardware 
Co.'s  invoice  of  April  17,  less  discount.  Cash  sales  for  the  week,  $395.00. 


236  PRINCIPLES  OF  ACCOUNTING 

April  20 

Pays  a  bill  at  the  garage,  $27.00,  for  supplies  and  work  on  the  car. 
Receives  invoice  from  Simmons  Hardware  Co.,  $300.00,  2/io/n/3o.  Cash 
sales,  $69.00. 

April  jo 

Herman  Rowe  pays  his  account  to  da'te.  Sells  Henry  Greiner  $90.00 
on  account.  Cash  sales,  $105.00. 

Post  all  accounts  up  to  date  and  take  a  trial  balance.  Merchandise 
inventory  April  30  is  $6,740.00.  Office  supplies  on  hand  amount  to  $35.00. 
Depreciation  on  the  auto  truck  is  taken  to  be  24  per  cent  for  the  year,  and 
on  office  and  store  equipment  it  is  taken  to  be  1 2  per  cent  yearly.  Make  all 
necessary  adjustments  for  insurance  and  interest,  in  order  to  show  as 
correctly  as  possible  the  true  amount  of  the  month's  profit  or  loss.  The 
pay-roll  for  two  days  (one-third  of  a  week)  is  accrued. 

Make  all  the  entries  necessary  to  adjust  the  accounts  and  close  the 
books,  and  post  these  entries  to  the  ledger. 

Prepare  a  balance  sheet  as  of  April  30,  and  a  statement  of  profit  and 
loss  for  the  month  of  April. 


CHAPTER  XXI 

CONTROLLING  ACCOUNTS 

Some  uses  of  special  columns.  Chapters  xix  and  xx  were  devoted 
to  a  discussion  of  the  books  of  original  entry,  with  particular  emphasis 
on  the  use  of  special  columns  in  such  books.  There  appeared,  from 
this  discussion,  at  least  three  distinct  advantages  resulting  from  the 
use  of  special  columns  in  the  various  journals.  These  advantages 
are:  (i)  greater  simplicity  in  posting;  (2)  further  analysis  of  particu- 
lar classes  of  transactions;  (3)  a  further  check  on  the  accuracy  of  the 
entries.  There  is  another  advantageous  use  that  may  be  made  of  the 
special  column.  This  is  its  use  in  grouping  a  certain  class  of  items  of 
a  similar  nature  for  posting  to  a  single  account  in  the  ledger,  while 
allowing  the  details  of  this  class  of  items  to  be  shown  in  some  form  of 
subsidiary  record. 

The  controlling  account.  Accounts  Receivable  furnishes  an 
example  of  such  a  class  of  items,  and  Accounts  Payable  another. 
These  two  will  be  discussed  in  this  chapter  as  representative  of 
controlling  accounts,  since  they  are  the  two  examples  of  the  controlling 
account  which  are  used  in  the  accounting  of  nearly  every  business 
concern.  Thus  in  the  case  of  a  business  which  sells  on  account  to  a 
considerable  number  of  customers,  it  is  clearly  undesirable  to  carry 
an  account  in  the  general  ledger  with  each  one  of  these  customers. 
Such  a  practice  would  make  the  ledger  accounts  so  numerous  as  to 
cause  confusion  and  make  the  work  of  obtaining  a  trial  balance  at  the 
end  of  a  period  a  slow  and  difficult  process.  It  is  much  better  to 
carry  the  accounts  with  individual  customers  in  a  separate  "customers' 
ledger"  or  "sales  ledger,"  and  to  carry  in  the  general  ledger  an  account 
entitled  Accounts  Receivable,  to  which  all  debits  and  credits  to 
customers  will  be  posted.  The  posting  to  this  general  ledger  account 
will  be  done,  for  the  most  part,  from  the  footings  of  certain  special 
columns  in  the  books  of  original  entry. 

The  method  by  which  this  is  accomplished  can  best  be  made  clear 
by  means  of  an  illustration,  which  will  be  made  as  simple  as  possible. 

23? 


238  PRINCIPLES  OF  ACCOUNTING 

Assume,  then,  a  small  retail  business  in  which  practically  all  pur- 
chases are  made  on  account,  and  in  which  sales  are  made  both  on 
account  and  for  cash.  The  following  books  of  entry  are  used:  (i)  a 
general  journal;  (2)  a  purchases  journal;  (3)  a  sales  journal;  (4)  a 
cash  book:  (a)  cash  receipts  journal,  (6)  cash  disbursements  journal. 

All  purchases  are  entered  in  the  purchases  journal  as  purchases  on 
account  and  so  posted,  the  payments  being  recorded  in  the  cash  book 
if  made  by  cash,  and  in  the  general  journal  if  by  note.  All  sales  on 
account  are  recorded  in  the  sales  journal,  cash  sales  being  entered 
in  the  cash  book.  No  attempt  is  made  to  show  any  analysis  of  either 
purchases  or  sales  in  the  books  of  original  entry.  Sales  tickets  are 
made  out  in  duplicate  for  each  sale,  different  colors  being  used  for 
cash  and  credit  sales.  The  amount  of  each  charge  sale  (meaning  by 
"sale"  the  total  of  the  goods  sold  to  any  customer  at  one  time)  is 
entered  separately  in  the  sales  journal,  while  the  cash  sales  tickets  are 
totaled  at  the  end  of  each  day  and  entered  in  the  cash  book  as  a  single 
item,  debiting  cash  and  crediting  sales. 

The  forms  to  be  used  for  the  purchases  journal  and  the  sales 
journal  in  such  a  business  may  be  made  very  simple  indeed.  Such 
forms  are  shown  on  pages  219  and  215,  respectively.  Each  of  them 
has  only  one  money  column,  headed  "Amount."  And  if  controlling 
accounts  are  not  to  be  carried  for  customers  or  creditors,  the  cash 
book  might  be  equally  simple,  providing  only  one  money  column  in 
each  of  the  cash  journals,  as  shown  on  page  141. 

Assume,  however,  that  it  is  intended  to  make  use  of  "controlling" 
accounts  for  accounts  receivable  and  accounts  payable.  This  means 
that  there  will  appear  in  the  general  ledger  a  single  account  which  will 
show  the  total  due  from  customers  on  open  account,  and  a  single 
account  to  show  the  total  due  to  creditors  on  open  account.  These 
two  accounts,  known  as  "Accounts  Receivable"  and  "Accounts  Pay- 
able," respectively,  are  controlling  accounts.  The  detailed  debits  and 
credits  to  each  customer  will  be  entered  in  his  individual  account  in  a 
subsidiary  ledger  known  as  the  "customers'  ledger"  or  "sales  ledger." 
Similarly,  the  individual  account  of  each  creditor  will  appear  in  another 
subsidiary  ledger  known  as  the  "creditors' ledger"  or  "purchases 
ledger." 

This  change  in  the  ledger  accounts  will  necessitate  certain  modifica- 
tions of  the  forms  of  books  of  original  entry,  as  previously  illustrated. 


CONTROLLING  ACCOUNTS 


239 


This  is  not  true  of  the  purchases  journal  or  the  sales  journal, 
however,  under  the  conditions  assumed  for  this  business.  Thus,  in 
order  to  carry  an  Accounts  Receivable  account  it  is  not  necessary 
to  change  the  form  of  the  sales  journal,  nor  to  introduce  any  additional 
columns.  Since  the  sales  recorded  are  all  sales  on  account,  the  foot- 
ing of  the  single  "Amount"  column  may  be  posted  not  only  to  the 
credit  of  sales  but  at  the  same  time  to  the  debit  of  accounts  receivable. 
The  amount  of  each  sale  would  be  posted  to  the  debit  of  the  account 
with  the  individual  customer,  irr*the  ''customers'  ledger,"  or  "sales 
ledger,"  such  posting  being  made  either  from  the  items  entered  in  the 
sales  journal  or  from  the  sales  tickets  or  invoices. 

But  while  the  same  form  of  sales  book  may  be  employed  to  record 
the  debits  to  customers,  some  modification  must  be  made  in  any  form 
of  journal  which  is  used  to  record  the  credits  to  customers.  The 
greater  part  of  such  credits  are  entered  on  the  debit  or  receipts  side  of 
the  cash  book.  If  the  Accounts  Receivable  account  in  the  general 
ledger  is  to  be  used  as  a  control  on  all  accounts  with  individual  cus- 
tomers, a  column  for  "Accounts  Receivable,  Credit"  must  be  included 
in  the  cash  receipts  journal.  If  posting  to  the  credit  of  customers' 
accounts  is  to  be  done  from  the  cash  receipts  journal  and  not  from 
remittance  slips  or  other  vouchers,  a  separate  ledger  folio  column  will 
be  needed  to  show  postings  to  the  customers'  ledger.  If  cash  discounts 
are  to  be  granted  to  customers,  still  another  column  will  be  needed 
in  the  cash  receipts  journal  for  "Cash  Discount  on  Sales,  Debit." 
Since  such  discounts  are  not  usually  allowed  hi  a  retail  business,  the 
cash  receipts  journal  might  take  the  following  form: 

CASH  RECEIPTS 


Date 

Account 
Credited 

Explanation 

General 
L.F. 

Cus- 
tomers' 
L.F. 

General 
Ledger 
Cr. 

Accounts 
Receiv- 
able 
Cr. 

Sales 
Cr. 

Casl 
Dr. 

Tan. 

X 

Balance 

On  hand 

3,500 

2 

H.  B.  Reed 

On  account 

5° 

00 

5° 

2 

Sales 

Cash  sales 

8s 

oo 

»<; 

^ 

Int.  on  bonds 

Int.  fifth  L.L. 

10 

00 

10 

4 

B.  L.  Strong 

In  full  of  acct. 

80 

00 

80 

It  will  be  apparent  that  in  using  this  form  of  cash  receipts  journal 
no  posting  of  single  items  will  be  made  into  the  general  ledger  except 


240  PRINCIPLES  OF  ACCOUNTING 

from  the  column  headed  "General  Ledger,  Cr."  In  this  column  are 
entered  the  amounts  to  be  credited  to  general  ledger  accounts  whose 
names  appear  in  the  "Account  Credited"  column,  and  for  which  no 
special  column  is  provided.  The  credit  to  sales  will  be  posted,  as 
explained  previously,  through  the  footing  of  the  column  for  sales. 
The  total  of  the  column  headed  "Accounts  Receivable,  Cr."  will  be 
posted  to  the  credit  of  the  controlling  account,  accounts  receivable,- 
in  the  general  ledger,  while  the  credits  to  the  individual  customers' 
accounts  will  be  posted  item  by  itefn  to  the  appropriate  accounts  in 
the  customers'  ledger,  the  total  of  these  items  being,  of  course,  the 
same  as  the  total  of  the  column.  A  separate  folio  column  is  provided 
for  the  folio  numbers  in  the  customers'  ledger. 

It  is  apparent  that  following  this  procedure  in  connection  with 
the  record  of  sales  on  account  and  with  cash  receipts  would  result  in 
having  posted  into  a  single  account  in  the  general  ledger,  at  the  end 
of  the  accounting  period,  the  total  of  the  debits  made  to  customers 
for  merchandise  sold  them  on  account,  and  also  the  total  of  the 
credits  made  to  these  customers  for  cash  received  in  payment  of 
their  accounts.  The  items  composing  the  total  of  such  a  debit  will 
have  been  posted  to  the  proper  accounts  in  the  subsidiary  ledger, 
as  will  the  items  composing  the  total  credit  mentioned  above. 
If  no  entries  were  made  to  the  debit  or  credit  of  customers'  accounts 
from  any  other  books  of  original  entry,  then  it  is  evident  that,  when  all 
posting  had  been  done  to  date,  the  balance  in  Accounts  Receivable,  the 
controlling  account,  would  equal  the  total  of  the  balances  of  the 
customers'  accounts.  In  the  type  of  business  under  discussion,  any 
entries  made  to  the  customers'  accounts  which  are  not  recorded  in 
one  of  these  two  journals  would  be  recorded  in  the  general  journal. 
Any  such  entry  made  in  the  general  journal  and  affecting  accounts 
receivable  would  need  to  indicate  not  only  the  debit  or  credit  to 
accounts  receivable  in  the  general  ledger  but  also  the  name  of  the 
customer's  account  which  was  to  be  debited  or  credited  in  the  cus- 
tomers' ledger.  Thus  if  B.  L.  Strong  had  given  his  note  for  the 
amount  of  his  account,  instead  of  paying  cash,  the  entry  would  have 
been  made  in  the  general  journal,  the  journalization  being  as  follows: 

Notes  receivable $80.00 

Accounts  receivable,  B.  L.  Strong         ....  $80.00 


CONTROLLING  ACCOUNTS 


241 


The  credit  would  be  posted  to  accounts  receivable  in  the  general 
ledger,  and  also  to  the  credit  of  Strong's  account  in  the  customers' 
ledger,  so  that  the  control  on  the  individual  accounts  would  still  be 
maintained  in  the  accounts  receivable  account.  This  principle  must 
always  be  held  in  mind  in  making  any  entry  by  which  a  controlling 
account  is  affected. 

Assuming  that  the  retail  establishment  under  discussion  had 
dealings  with  several  wholesale  houses  from  which  they  purchased 
merchandise  on  account,  it  is  probable  that  they  would  also  make  use 
of  a  creditors'  ledger  to  show  the  detail  of  these  accounts,  with  a 
controlling  account  in  the  general  ledger,  headed  "Accounts  Payable." 
The  same  form  of  purchases  journal  that  has  already  been  discussed  (see 
page  219)  could  be  used,  provided  a  different  procedure  were  followed 
in  posting  from  this  journal.  Since  the  amounts  entered  in  this 
record  all  represent  purchases  on  account,  the  total  would  be  posted 
to  the  debit  of  Purchases  and  to  the  credit  of  Accounts  Payable. 
The  credits  to  the  accounts  of  the  individual  creditors  might,  as  in 
the  case  of  the  sales,  be  posted  either  from  the  entries  in  the  book  of 
original  entry  or  from  the  invoices. 

The  chief  source  of  credit  posting  to  Accounts  Payable  is  the  cash 
disbursements  journal,  in  which  payments  to  creditors  are  recorded. 
A  form  of  Such  a  journal  which  would  fill  the  needs  of  such  a  business 
as  the  one  assumed  here  is  as  follows: 

x 

CASH  DISBURSEMENTS 


Cash 

Date 

Account 
Debited 

Explanation 

General 
L.  F. 

Credi- 
tors' 
L.F. 

General 
Ledger 
Dr. 

Accounts 
Payable 
Dr. 

Discount 
on  Pur- 
chases 

Cask 
Cr 

Cr. 

Jan. 

i 

Rent 

Rent  for  Jan. 

100 

00 

100 

a 
•\ 

Smith  Si  Co. 
Notes  payable 

Invoice\o.i4S 
Hyde  Park 

500 

00 

10 

00 

490 

Bank  12/2 

1,000 

00 

I,  COO 

4 

Wilson  &  Co. 

Invoice  No.  147 

4SO 

00 

9 

00 

441 

In  using  such  a  form  as  this,  each  item  entered  in  the  "  General 
Ledger,  Dr."  column  would  be  posted  separately  to  the  debit  of  the 
account  whose  name  appears  opposite  it  in  the  "Account  Debited" 
column.  The  total  of  the  column  headed  "Accounts  Payable,  Dr." 


242  PRINCIPLES  OF  ACCOUNTING 

would  be  posted  to  the  debit  of  that  account  in  the  general  ledger, 
each  item  in  that  column  being  posted  separately  to  the  individual 
creditor's  account  in  the  creditors'  ledger.  The  footing  of  the  column 
headed  "Cash  Discount  on  Purchases"  would  be  posted  to  the  credit 
of  the  account  of  that  title.  The  last  column,  headed  "  Cash,  Cr.," 
is  used  to  show  the  net  cash  payment  involved  in  each  case,  and  is  in 
effect  the  credit  side  of  the  cash  account,  the  debit  side  being  the 
"Cash,  Dr."  column  in  the  cash  receipts  journal. 

Entries  for  transactions  affecting  any  of  the  accounts  with  trade 
creditors  which  do  not  happen  to  fall  into  either  the  purchases  journal 
or  the  cash  disbursements  journal  must  still  be  made  in  such  a  way  as 
to  make  possible  the  posting  to  both  the  item  account  in  the  subsidiary 
ledger  and  to  the  controlling  account  in  the  general  ledger.  The 
principle  governing  this  was  discussed  in  connection  with  accounts 
receivable,  and  what  was  said  there  applies  also  to  the  creditors' 
accounts.  Thus,  if  the  business  returns  to  a  trade  creditor  unsatis- 
factory goods  to  the  amount  of  Sioo,  the  entry  could  not  be  made  in 
any  of  the  special  journals  discussed  above,  but  would  have  to  be 
made  in  the  general  journal,  the  journalization  being  as  follows: 

Accounts  Payable,  Smith  Brothers        .       .     Sioo.oo 

Purchase  Returns  and  Allowances         .       .       .         $100.00 

The  debit  here  would,  as  stated  above,  be  posted  both  to  the  general 
ledger  account  and  to  the  item  account  in  the  subsidiary  ledger. 

The  use  of  the  controlling  account  illustrated.  The  relation  of  the 
controlling  account  to  the  subsidiary  ledger  which  it  controls,  and  the 
relations  of  the  special  columnar  journals  to  each  other  and  to  the  use 
of  the  controlling  accounts,  may  be  made  clearer  by  means  of  a  simple 
illustration.  This  illustration  will  present  all  the  books  of  entry 
which  would  be  required  by  a  simple  retail  business.  Representative 
entries  will  be  made  hi  these  books,  and  the  effect  of  these  entries 
on  the  accounts  will  be  depicted.  It  would  of  course  be  impracticable 
to  show  the  entries  for  a  month's  business,  but  for  purposes  of  illus- 
tration the  few  entries  shown  below  may  be  taken  as  representing  the 
total  business  transactions  for  a  month.  The  skeleton  ledger  accounts, 
used  to  represent  the  ledger,  are  numbered,  the  number  of  each 
representing  the  page  upon  which  that  account  is  found.  The  forms 


CONTROLLING  ACCOUNTS 


243 


of  the  various  journals  are  those  already  illustrated  and  discussed. 
They  are  combined  here  into  what  might  be  called  a  tabloid  set  of 
books,  as  follows: 

PURCHASES  JOURNAL  Page  1 


Date 

L.F. 

Name  of  Creditor 

Address 

Terms 

Invoice 

Number 

Accounts 
Payable,  Cr. 

Oct. 

I 

4 

Hart,     Schaffner 

&  Marx 

2/io/n/3o 

I 

600 

00 

4 

i 

Adler  Bros. 

2/io/n/3o 

2 

750 

oo 

10 

5 

Johnson  &  Mur- 

phy 

Net  30 

3 

500 

00 

16 

6 

Wilson  Bros. 

2/io/n/3o 

4 

45° 

00 

i7 

7 

J.  B.  Stetson  Co. 

2/io/n/6o 

5 

300 

oo 

24 

2 

Black   Cat   Tex- 

tile Co. 

2/io/n/30 

6 

250 

00 

2y 

3 

duett,   Peabody 

&Co. 

Net  30 

7 

300 

00 

31 

L.Q 

Purchases,  Dr. 

(4)3,150 

00 

NOTE. — It  will  be  seen  here  that  there  are  two  items  posted  to  the  general 
ledger,  both  of  the  same  amount.  The  ledger  page  of  the  purchases  account  is  in- 
dicated in  the  folio  column  at  the  left.  That  of  accounts  payable  is  shown  in 
parenthesis  just  to  the  left  of  the  footing  of  the  amount  column. 


SALES  JOURNAL 


Page  1 


Date 

L.F. 

Name  of  Customer 

Address 

Terms 

Invoice 
No. 

Accounts 
Receivable, 
Dr. 

Oct. 

i 

I 

0.  L.  Buhr 

1214  Fourth  St. 

I 

7500 

4 

6 

D.  Tollefson 

515  Oak  St. 

2 

5000 

8 

4 

H.  A.  Howard 

744  University  Ave. 

3 

3500 

10 

5 

P.  T.  Nelson 

1525  Riverside  Ave. 

4 

12  50 

H 

7 

A.  Wyman 

1206  Como  Ave. 

5 

65  oo 

i7 

i 

O.  L.  Buhr 

1214  Fourth  St. 

6 

1450 

20 

3 

F.  T.  Enke 

625  Ninth  Ave. 

7 

6000 

24 

6 

D.  Tollefson 

515  Oak  St. 

8 

1800 

27 

5 

P.  T.  Nelson 

1525  Riverside  Ave. 

9 

5000 

3° 

2 

F.  B.  Barton 

78  Prospect  Place 

10 

6500 

3i 

L.7 

Sales,  Cr. 

(i)  44500 

NOTE. — The  folio  numbers  of  the  general  ledger  accounts  affected  are  shown 
in  the  same  manner  as  in  the  purchases  journal.  Thus  the  page  of  sales  account 
is  indicated  in  the  folio  column,  while  that  of  accounts  receivable  is  written  in 
parenthesis  next  to  the  footing  of  the  amount  column. 


244 


PRINCIPLES  OF  ACCOUNTING 

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CONTROLLING  ACCOUNTS 


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246 


PRINCIPLES  OF  ACCOUNTING 
JOURNAL 


Page  1 


Oct.  i 

Cash 

6,500 

oo 

2 

Notes  Receivable 

IOO 

oo 

6 

J.  B.  Wright,  Proprietor 

6,600 

00 

To  record  J.  B.  Wright's  original 

investment    in    retail    clothing 

business 

(Cash  $6,500  and  F.  Johnson's 

note   for   $100,   dated   8/7/19, 

with  interest  at  6  per  cent) 

25 

2 

Notes  Receivable 

60 

00 

i/3 

Accounts  Receivable,  F.  T.  Enke 

60 

00 

His    thirty-day    note    without 

interest  for  our  Invoice  No.  118 

29 

5/6 

Accounts  Payable,  \Vilson  Bros. 

125 

oo 

10 

Purchase  Returns  and  Allowances 

125 

00 

Returned  unsatisfactory  goods 

Invoice  No.  78 

30 

8 

Sales  Returns  and  Allowances 

20 

oo 

i/5 

Accounts  Receivable,  P.  T.  Nelson 

20 

00 

Returned  goods  on  Invoice  No.  9 

GENERAL  LEDGER 

ACCOUNTS  RECEIVABLE 


Page  1 


Oct.  31 

SJ  i 

445 

OO 

Oct.  31 

30 
25 

C    2 

J  i 
J  i 

243 
20 
60 

00 
00 

oo 

NOTES  RECEIVABLE                                     Page  2 

Oct.   i 

25 

J  i 

J  i 

IOC 

6c 

joo 
oo 

Oct.    7 

C    2 

IOO 

00 

OFFICE  EQUIPMENT                                      Page  3 

Oct.  17 

C  3 

225 

DO 

^ 
ACCOUNTS  PAYABLE                                     Page  4 

Oct.  31 
29 

C3 
J  i 

2,100 
125 

DO 
DO 

Oct.  31 

PJ    I 

3,15° 

00 

CONTROLLING  ACCOUNTS 
J.  B.  WRIGHT,  PROPRIETOR 


MERCHANDISE  SALES 


SALES  RETURNS  AND  ALLOWANCES 


MERCHANDISE  PURCHASES 


PURCHASES  RETURNS  AND  ALLOWANCES 


247 
Page  6 


Oct.    i 

Investment 

J  * 

6,600 

00 

Page6 


Oct.  31 
3i 

s^ 

445 
960 

00 
00 

Page? 


Oct.  30 

J  i 

20 

00 

PageS 


Oct.  3  1 

PJi 

3,150,00 

Page  9 


Oct.  29 

Ji 

125 

00 

SALES  SALARIES                                       Page  10 

Oct.   6 
13 

20 
27 

oono 

CM  CM  CM  CM 

"5 
"5 
"5 
"5 

oo 
oo 
oo 
oo 

OFFICE  EXPENSE                                    Page  11 

Oct.   3 
30 

c3 

60 

18 

oo 
oo 

RENT                                               Page  12 

Oct.    i 

C3 

IOO 

oo 

CASH  DISCOUNT  ON  PURCHASES                         Page  13 

Oct.  31 

C3 

42 

00 

INTEREST  ON  NOTES  RECEIVABLE                        Page  14 

Oct.    7 

C    2 

I 

00 

248 


PRINCIPLES  OF  ACCOUNTING 

CUSTOMERS'  LEDGER 
O.  L.  BUHR,  1214  FOURTH  STREET 


Pagel 


Oct.   i 

i? 

S  i 
S  i 

75 
14 

oo 
50 

Oct.  ii 

C    2 

75 

oc 

F.  B.  BARTON,  78  PROSPECT  PLACE                         Page  2 

Oct.  30 

S  i 

65  oo 

F.  T.  ENKE,  625  NINTH  AVENUE                           Page  3 

Oct.  20 

S  i 

60 

oo 

Oct.  25 

J  i 

60 

CXI 

H.  A.  HOWARD,  744  UNIVERSITY  AVENUE                     Page  4 

Oct.   8 

. 

S  i 

35 

oo 

Oct.  21 

C    2 

35oo 

P.  T.  NELSON,  1525  RIVERSIDE  AVENUE                    Page  6 

Oct.  ii 

27 

S  i 
S  i 

12 

5° 

5° 

00 

Oct.  30 

J    I 

20 

00 

D.  TOLLEFSON,  515  OAK  STREET                           Page  6 

Oct.   4 

24 

S  i 
S  i 

5° 
18 

oo 
oo 

Oct.  17 
30 

C   2 

C    2 

50 

18 

00 

oo 

A.  D.  WYMAN,  1206  COMO  AVENUE                         Page  7 

Oct.  14 

S  i 

65 

00 

Oct.  29 

C    2 

65 

00 

CREDITORS'  LEDGER 

ABLER  BROTHERS 


BLACK  CAT  TEXTILE  COMPANY 


Pagel 


Oct.  13 

C3 

75o 

00    | 

Oct.    4 

P  i 

75° 

oo 

Page  2 


Oct.  17 

P  i 

250 

00 

CONTROLLING  ACCOUNTS 
CLUETT,  PEABODY  &  COMPANY 


249 
Page3 


Oct.  29 


HART,  SCHAFFNER  &  MARX 


Page* 


Oct.    9 

c  •* 

600 

ooj 

Oct.    i 

P  i 

600 

00 

JOHNSON  AND  MURPHY 


Page  6 


Oct.  10 

P  i 

500 

00 

WILSON  BROTHERS 


Page  6 


Oct.  29 
26 

J  i 
C3 

125 
45° 

oo 

00 

Oct.  16 

P  i 

45° 

00 

J.  B.  STETSON  COMPANY 


Page? 


Oct.  27 

C3 

300 

00 

Oct.  17 

P  i 

300 

00 

A  trial  balance  taken  from  the  ledger  at  the  end  of  the  month 
appears  as  follows: 

J.  B.  WRIGHT 

TRIAL  BALANCE — OCTOBER  31,  1919 

Cash $4,843.00 

Accounts  receivable 122.00 

Notes  receivable 60.00 

Office  equipment 225.00 

Accounts  payable $   925.00 

J.  B.  Wright,  capital 6,600.00 

Sales 1,405.00 

Sales  returns  and  allowances    .       .       .  20.00 

Purchases 3,150.00 

Purchase  returns  and  allowances 125.00 

Sales  salaries 500.00 

Office  expense 78.00 

Rent 100.00 

Cash  discount  on  purchases 42.00 

Interest  on  notes  receivable  i.oo 


$9,098.00        $9,098.00 


2  SO  PRINCIPLES  OF  ACCOUNTING 

The  two  subsidiary  ledgers  may  be  summarized  as  follows: 
Schedule  No.  I — Accounts  Receivable 

O.  L.  Buhr $  14.50 

F.  B.  Barton 65.00 

P.  T.  Nelson       .  42.50 

Total $122.00 

Schedule  No.  2 — Accounts  Payable 

Black  Cat  Textile  Co $   250.00 

Cluett,  Peabody  &  Co 300.00 

Johnson  &  Murphy    ......  500.00 

Total $1,050.00 

Less  Wilson  Bros,  (debit  balance)    .       ,       .          125.00 

Balance $   925.00 

It  will  be  noted  that  the  result  of  each  of  these  summaries  agrees 
with  the  balance  shown  by  the  controlling  account  for  the  subsidiary 
ledger  in  question. 

Summary.  The  principles  which  have  been  developed  in  con- 
nection with  the  use  of  the  controlling  account  may  be  summarized 
as  follows: 

1.  If  a  group  of  accounts  of  similar  nature  becomes  very  numerous, 
it  is  often  undesirable  to  carry  the  individual  accounts  which  compose 
this  group  in  the  general  ledger.     (For  example:  "Accounts  Receiv- 
able," "Accounts  Payable,"  "Machinery,"  "Raw  Materials.") 

2.  The  situation  described  in  (i)  may  be  met  by  carrying  the 
individual  accounts  of  this  group  in  a  special  subsidiary  ledger,  and 
carrying  hi  the  general  ledger  a  single  controlling  account  for  the 
entire  group. 

3.  The  use  of  a  subsidiary  ledger  and  a  controlling  account  neces- 
sitates some  means  of  posting  the  items  of  debit  and  credit  to  the 
individual  accounts,  and  also  of  posting  the  same  items  hi  summarized 
form  into  the  controlling  account. 

-  4.  In  order  to  secure  postings  in  summarized  form  to  a  controlling 
account,  special  columns  will  be  required  in  books  of  original  entry  in 
which  entries  are  made  affecting  such  controlling  account. 

5.  Posting  to  the  accounts  in  the  subsidiary  ledger  may  be  made 
either  from  the  individual  entries  in  the  books  of  original  entry,  or 


CONTROLLING  ACCOUNTS  251 

directly  from  the  vouchers  made  out  in  connection  with  the  transac- 
tions which  affect  these  individual  accounts. 

Also,  the  discussion  and  the  illustrations  given  hi  this  chapter 
should  indicate  that  at  least  four  purposes  may  be  served  by  special 
columns  in  books  of  original  entry.  These  four  purposes  are: 
(i)  the  saving  of  labor  in  posting;  (2)  check  on  the  equality  between 
debit  and  credit  entries  in  any  given  journal,  obtained  by  comparing 
the  totals  of  the  debit  columns  with  the  totals  of  the  credit  columns; 
(3)  analysis  of  data  in  the  books  of  original  entry;  (4)  the  use  of 
subsidiary  ledgers  and  controlling  accounts. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  You  are  asked  to  design  a  complete  accounting  system  for  a  wholesale 
hardware  establishment.    Outline  the  information  which  you  should 
require  before  you  could  decide  upon  the  form  of  the  various  books  of 
original  entry. 

2.  Define  the  controlling  account.     Give  examples  of  such  accounts. 
What  are  the  advantages  in  the  use  of  controlling  accounts? 

3.  Refer  to  the  books  of  original  entry  that  you  were  asked  to  plan  for  the 
use  of  the  Miller  Company  and  the  Saunders  Company,  in  the  questions 
at  the  end  of  chapters  xix  and  xx.    Would  you  need  to  modify  these 
forms  in  order  to  make  use  of  controlling  accounts  with  accounts  receiv- 
able and  accounts  payable  ?    Why,  or  why  not  ?    If  such  modifications 
are  necessary,  describe  them  in  detail. 

4.  Give  an  analysis  of  the  debits  and  the  credits  that  affect  the  account 
with  accounts  receivable.    Through  what  book  or  books  of  original 
entry  will  each  of  these  debits  and  credits  be  posted  ? 

5.  Answer  the  same  questions  with  regard  to  accounts  payable  that  are 
asked  in  Question  4  with  regard  to  accounts  receivable. 

6.  Referring  again  to  the  Miller  Company,  assume  that  they  use  a  sub- 
sidiary ledger  for  accounts  with  trade  creditors,  one  for  city  customers, 
and  one  for  country  customers,  and  that  all  posting  to  these  subsidiary 
ledgers  is  done  directly  from  the  vouchers.     You  are  asked: 

o)  To  design  a  complete  set  of  books  of  original  entry  for  this  company. 

b)  To  describe  in  detail  the  posting  to  be  made  from  each  of  the  books 
of  original  entry. 

c)  To  describe  in  detail  the  posting  to  the  item  accounts  in  the  sub- 
sidiary ledger,  telling  what  vouchers  are  used  for  this  posting. 

What  bases  of  analysis  do  the  books  of  original  entry  which  you  have 
designed  provide  for  each  class  of  transactions  ?  Discuss  the  value  of 
each  such  basis  of  analysis. 


252  PRINCIPLES  OF  ACCOUNTING 

7.  Can  you  suggest  any  classes  of  accounts  beside  accounts  with  customers 
and  accounts  with  creditors,  which  might  advantageously  be  kept  in 
subsidiary  ledgers?  If  so,  outline  a  method  of  recording  the  debits 
and  credits  to  such  accounts,  and  of  posting  these  debits  and  credits 
to  the  general  ledger  and  to  the  subsidiary  ledger. 

REFERENCES  FOR  FURTHER  STUDY 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chaps,  xlvi  and 

xlvii. 

ESQUERRE,  PAUL- JOSEPH,  Applied  Theory  of  Accounts,  chap.  xi. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  pp.  96-102. 


CHAPTER  XXH 

THE  CONSTRUCTION  AND  INTERPRETATION 
OF  ACCOUNTS— ASSETS 

Chapters  vi  and  vii  were  devoted  to  a  consideration  of  the  con- 
struction and  interpretation  of  various  kinds  of  accounts.  The  dis- 
cussion there  given  was  quite  elementary  and  did  not  mention  some 
accounts  which  are  frequently  used.  Beginning  with  the  present 
chapter,  that  earlier  discussion  will  be  reviewed  and  some  things 
will  be  introduced  which  were  there  omitted. 

In  doing  this,  the  method  of  approach  employed  will  be  the  same 
as  that  employed  in  the  earlier  discussion  of  the  subject.  Thus,  in 
connection  with  each  account  taken  up,  the  following  points  will  be 
considered:  (i)  the  purpose  of  the  account;  i.e.,  the  information 
which  is  sought  from  the  account;  (2)  the  transactions  which  are  to 
be  recorded  in  it,  or  the  debits  and  credits  which  are  to  be  made  to  it; 
(3)  what  the  balance  of  the  account  represents,  and  what  disposition 
is  made  of  this  balance  in  the  accounting  reports. 

Cash  account.  Cash  has  already  been  considered  from  various 
aspects,  and  there  is  nothing  to  be  gained  by  repeating  some  of  the 
points  that  have  previously  been  made.  The  student  may  be  re- 
minded, however,  that  Cash  includes  not  only  money  of  all  kinds  but 
commercial  paper,  such  as  checks,  bank  drafts,  and  money  orders, 
which  is  immediately  bankable  without  being  discounted.  It  also 
includes  credit  which  the  business  may  have  with  any  bank.  Such 
credit  may  be  established  by  depositing  money  or  bankable  paper, 
or  by  borrowing  from  the  bank.  Borrowing  from  the  bank  may  be 
accomplished  either  by  giving  the  one-name  note  of  the  borrowing 
concern,  or  by  discounting  a  note  or  trade  acceptance  on  which  some 
trade  debtor  of  the  borrowing  firm  is  primarily  liable.  Credit  with 
the  bank  may  also  arise  through  collections  from  customers  made 
by  the  bank  and  deposited  to  the  credit  of  the  business,  through 
interest  accruing  on  the  balance  at  the  bank,  and  through  collections 
of  interest  coupons  (on  bonds) . 

253 


254 


PRINCIPLES  OF  ACCOUNTING 


The  transactions  affecting  the  Cash  account,  and  the  debits  and 
credits  to  be  made  to  that  account,  may  be  indicated  as  follows: 


CASH 


Debit: 

With  the  amount  of  all  money  and 
bankable  paper  received. 

With  all  credits  made  to  the  account 
of  the  business  (aside  from  credits 
made  as  a  result  of  the  deposit  of 
the  foregoing)  by  the  bank,  for  col- 
lections, interest,  etc. 


Credit: 
With  all  money  paid  out  in  the  form 

of  currency  (usually  from  a  petty 

cash  fund). 

With  all  checks  drawn. 
With  all   other  charges  made  to  the 

account  of  the  business  by  the  bank, 

for  any  cause  whatever. 


The  entries  for  all  these  debits  and  credits  will  be  made  in  the 
cash  book,  as  previously  explained.  The  amount  of  cash  on  hand 
(held  by  the  business)  at  any  time  includes  cash  received  by  the  busi- 
ness but  not  yet  deposited,  as  well  as  the  amounts  of  any  special 
funds  that  may  be  carried  by  the  business,  such  as  petty  cash,  office 
cash,  and  the  like. 

In  chapter  vii  it  was  stated  that  a  proof  of  cash  should  be  taken 
frequently.  It  is  also  desirable  to  affect  a  reconciliation  of  cash  as 
shown  by  the  records  of  the  business  with  the  figure  shown  by  the 
bank  statement,  whenever  such  a  statement  is  received.  This  means 
comparing  the  amount  of  unused  credit  at  the  bank  as  shown  by  the 
firm's  records  with  the  amount  of  such  credit  as  shown  by  the  bank 
statement.  The  figure  shown  by  the  records  of  the  business,  plus 
the  total  of  checks  drawn  but  not  included  in  the  bank  statement, 
should  equal  the  balance  shown  by  that  statement.  Any  discrepancy 
must  be  accounted  for  and  adjusted. 

A ccounts  Receivable.  Accounts  Receivable  is  a  controlling  account, 
showing  the  total  amount  owed  to  the  business  on  open  account  by  its 
customers.  Posting  to  this  account  is  done  chiefly  from  the  footings 
of  certain  special  columns  in.  the  books  of  original  entry,  while  the 
accounts  in  the  customers'  ledger,  which  show  the  amounts  due  from 
individual  customers,  are  posted  either  from  the  entries  in  the  book 
of  original  entry  or  directly  from  the  vouchers. 

The  kinds  of  transactions  affecting  the  Accounts  Receivable 
account,  and  the  nature  of  the  debits  and  credits  to  this  account, 
may  be  indicated  as  follows: 


CONSTRUCTION  OF  ACCOUNTS— ASSETS 
ACCOUNTS  RECEIVABLE 


255 


Debit: 

With  the  invoiced  price  of  all  sales 
to  customers  on  open  account. 

With  freight,  cartage,  etc.,  prepaid, 
where  such  items  are  added  on  the 
invoice  (sometimes  included  in  in- 
voiced»price). 

With  the  amount  of  notes  receivable 
given  by  customers  and  dishonored 
at  maturity,  when  such  dishonored 
notes  are  not  otherwise  recorded. 

With  all  charges  incurred  in  connec- 
tion with  notes  receivable  dishon- 
ored, when  such  charges  are  not 
debited  to  a  separate  account. 


Credit: 

With  cash  received  from  customers  in 
payment  of  accounts. 

With  the  amount  of  all  discounts 
allowed  to  customers  for  cash  pay- 
ments. 

With  the  amount  of  all  allowances 
and  rebates  of  any  sort  granted  to 
customers. 

With  notes  given  by  customers  in 
payment  of  accounts. 

With  the  invoice  price  of  goods  re- 
turned by  customers. 


The  balance  of  this  account  shows  the  total  owed  the  business  on 
open  account  by  its  customers.  It  is  desirable  that  the  individual 
accounts  should  be  totaled  rather  frequently,  perhaps  at  the  end  of 
each  month,  and  the  total  compared  with  the  balance  of  the  controlling 
account.  Any  discrepancy  should  be  discovered  and  explained,  and 
the  necessary  adjustments  made  to  bring  the  individual  accounts 
into  agreement  with  the  controlling  account. 

Reserve  for  Bad  Debts.  It  has  already  been  suggested  that  the 
assets  which  take  the  form  of  claims  against  customers  are  subject  to 
some  evaluation.  Experience  has  demonstrated  that  customers  do  not 
always  make  good  their  promises  to  pay.  In  order  to  guard  against 
an  overstatement  of  the  proprietorship  and  of  the  current  profits,  a 
charge  is  made  at  the  end  of  the  fiscal  period  to  an  account  with  bad 
debts,  or  loss  from  bad  debts,  and  a  credit  made  to  an  account  with 
reserve  for  bad  debts.  The  latter  account  is  a  valuation  account,  so 
named  because  it  is  used,  in  connection  with  an  asset  account,  for 
the  purpose  of  helping  to  show  the  correct  valuation  of  the  asset  in 
question.  It  is  similar  in  its  nature  to  the  depreciation  reserve 
accounts,  and  should- be  shown  on  the  balance  sheet  as  a  deduction 
from  the'  amount  of  the  total  accounts  receivable,  as  follows: 


Accounts  Receivable  . 
Reserve  for  Bad  Debts 


$2,500.00 
50.00 


$2,450.00 


PRINCIPLES  OF  ACCOUNTING 


The  amount  to  be  charged  against  income  and  credited  to  the  re- 
serve for  bad  debts  account  at  the  end  of  the  period  depends  partly 
on  the  experience  of  the  business,  and  partly  on  the  character  of  the 
accounts  receivable  at  that  particular  time.  It  should  be  sufficient 
each  period  to  cover  the  estimated  losses  of  that  period.  Whenever 
such  a  loss  is  definitely  ascertained  to  have  occurred,  the  reserve 
account  will  be  debited  and  the  customer's  account  credited  with  the 
amount  of  such  loss.  This  serves  to  write  off  the  now  worthless 
account,  and  to  indicate  that  a  loss  of  that  amount  has  actually  been 
sustained. 

The  type  of  transactions  affecting  the  Reserve  for  Bad  Debts 
account,  and  the  nature  of  the  debits  and  credits  to  be  made  to  this 
account,  may  be  indicated  as  follows: 

RESERVE  FOR  BAD  DEBTS 


Debit: 

With  the  amount  of  any  account  claim 
against  a  customer  which  is  written 
off  as  uncollectable. 


Credit: 

At  the  close  of  the  accounting  period 
with  the  amount  estimated  to  be 
equal  to  the  losses  from  bad  debts 
attributable  to  the  period  just  past. 


The  balance  of  such  an  account,  if  a  credit,  indicates  the  amount 
by  which  the  estimated  losses  exceed  the  actual  losses  ascertained  to 
that  date.  If  a  debit  balance,  it  shows  the  amount  by  which  such 
ascertained  losses  have  exceeded  the  estimate.  A  debit  balance  in 
this  account  may  mean  that  some  extraordinary  loss  has  occurred. 
Or  it  may  mean  that  the  the  actual  losses  for  the  period  have  exceeded 
the  credit  made  at  the  end  of  the  preceding  period.  Or  it  may  mean 
that  the  administration  of  credits  and  collections  has  been  inefficient. 
In  any  case  it  is  a  matter  of  interest  to  the  management,  and  requires 
an  explanation. 

Notes  Receivable.  The  nature  of  Notes  Receivable  and  the  cir- 
cumstances under  which  they  may  be  received  have  already  been 
discussed  rather  fully.  It  is  the  purpose  of  the  Notes  Receivable 
account  to  show  the  amount  of  short-time  notes  and  accepted  time 
drafts  held  by  the  business,  including  only  those  which  have  not  yet 
reached  maturity.  Where  notes  are  received  from  parties  other 
than  customers,  it  is  desirable  to  set  up  a  separate  Notes  Receivable 
account  for  such  notes. 


CONSTRUCTION  OF  ACCOUNTS— ASSETS 


257 


The  kind  of  transactions  which  affect  the  Notes  Receivable 
account,  and  the  nature  of  the  debits  and  credits  to  this  account,  are 
indicated  by  the  following: 

NOTES  RECEIVABLE 


Debit: 
With    the    face    value    of   all   notes 

received. 
With  the  face  value  of  accepted  time 

drafts  received. 


Credit: 

\Vith  the  amount  of  cash  or  other 
property  received  in  payment  of 
notes. 

With  the  face  value  of  any  notes 
transferred,  sold,  discounted,  or  in 
any  way  disposed  of. 

With  the  face  value  of  notes  dis- 
honored (not  paid  at  maturity). 


The  balance  of  this  account  shows  the  total  face  value  of  all  the 
unmatured  written  prdTnises  to  pay  received  by  the  business  from  its 
customers,  and  which  are  still  held  by  the  business.  As  stated  above, 
it  is  generally  well  to  have  a  separate  account  for  notes  received  from 
those  other  than  customers.  Also,  as  soon  as  a  note  passes  maturity 
without  being  paid,  it  should  no  longer  be  carried  under  the  head  of 
notes  receivable,  since  it  is  presumably  inferior  in  quality  to  the  other 
assets  composing  that  group,  and  should  therefore  be  valued  on  a 
different  basis.  Of  course,  where  a  business  holds  only  a  few  notes 
and  the  manager  knows  the  circumstances  in  connection  with  each, 
such  a  division  of  this  account  may  be  unnecessary. 

Notes  Receivable  Discounted.  It  is  quite  usual  for  a  business  con- 
cern to  discount  customers'  notes  at  the  bank,  in  order  to  secure  the 
means  of  meeting  its  own  obligations.  In  order  to  transfer  such  a 
note  to  the  bank,  it  must  be  indorsed  by  the  payee,  who  thus  assumes 
a  secondary  liability  for  its  payment  at  maturity.  In  most  such 
cases  the  bank  is  in  reality  lending  the  money  to  the  concern  which 
sold  the  goods,  and  which  discounts  the  note,  mainly  on  the  credit 
of  that  concern,  reinforced  by  whatever  additional  security  the 
signature  of  the  maker  may  represent.  For  if  at  maturity  the  maker 
fails  to  take  up  the  note  at  the  bank,  the  payee,  who  indorsed  it, 
must  do  so. 

When  a  customer's  note  is  discounted  at  the  bank,  therefore,  a 
credit  to  Notes  Receivable  scarcely  causes  the  accounts  to  reflect  the 
true  condition  of  affairs,  as  it  entirely  ignores  the  liability  to  the  bank 


258 


PRINCIPLES  OF  ACCOUNTING 


which  has  been  assumed  by  the  indorser.  This  liability  is  not  an 
absolute  one,  but  is  contingent  upon. the  failure  of  the  maker  to  pay 
the  note  at  maturity.  .  It  is  therefore  known  as  a  contingent  liability. 
There  is  more  than  one  way  hi  which  these  facts  may  be  shown  in  the 
accounts  and  on  the  balance  sheet.  One  method  which  is  acceptable 
will  be  indicated  here.  When  the  note  is  discounted,  cash  and  interest 
will  be  debited,  and  an  account  called  Notes  Receivable  Discounted  will 
be  credited.  This  leaves  the  amount  of  the  discounted  note  included 
in  the  balance  of  the  Notes  Receivable  account,  this  amount  being 
offset  by  the  credit  to  Notes  Receivable  Discounted. 

Assuming  the  balance  of  the  notes  receivable  account  to  be  $600, 
and  the  balance  of  the  Notes  Receivable  Discounted  account  to  be 
$200,  the  showing  on  the  balance  sheet  would  be  as  follows: 

Notes  Receivable $600 .  oo 

Less  Notes  Receivable  Discounted     .      *.       200 .  oo 

$400.00 

This  has  the  effect  of  showing  the  notes  receivable  at  their  net 
figure,  $400,  and  at  the  same  time  it  serves  notice  to  anyone  reading 
the  balance  sheet  that  a  contingent  liability  exists,  to  the  amount  of 
$200.  When  one  of  the  discounted  notes  matures,  if  no  notice  is 
received  from  the  bank  of  its  non-payment  by  the  maker,  an  entry 
is  made  debiting  Notes  Receivable  Discounted  and  crediting  Notes 
Receivable.  If  such  notice  is  received,  Notes  Receivable  Discounted  is 
debited  and  Cash  credited,  since  the  note  must  be  taken  up  at  the  bank 
by  the  indorser.  The  face  value  of  the  dishonored  note  is  then 
transferred  from  the  Notes  Receivable  account,  being  debited  either 
to  the  customer's  open  account  or  to  an  account  with  Notes  Receivable 
Dishonored,  which  will  be  considered  later. 

The  debits  and  credits  to  be  made  to  the  account  with  Notes 
Receivable  Discounted  may  be  indicated  as  follows: 

NOTES  RECEIVABLE  DISCOUNTED 


Debit: 

At  the  time  the  note  is  paid  with  the 
face  value  of  the  discounted  note 
paid. 

At  the  time  the  note  is  dishonored 
with  the  face  value  of  the  dis- 
counted note  dishonored  (crediting 
notes  receivable). 


Credit: 

At  the  time  of  discount  with  the  face 
value  of  the  notes  receivable 
discounted. 


CONSTRUCTION  OF  ACCOUNTS— ASSETS 


259 


Notes  Receivable  Dishonored.  As  indicated  in  the  foregoing,  a 
dishonored  note  should  not  continue  to  be  carried  in  the  Notes  Receiv- 
able account.  The  face  value  of  the  note  may  be  transferred  back  to 
the  customer's  open  account,  which  would  also  be  charged  with  any 
expenses  incurred  in  connection  with  the  note's  dishonor,  such  as 
protest  fees,  or  the  face  value  of  the  note  may  be  carried  to  an  account 
entitled  Notes  Receivable  Dishonored.  If  the  first  method,  that  of 
debiting  the  customer's  account,  is  used,  special  attention  must  be 
given  to  the  valuation  of  such  accounts  for  balance-sheet  purposes. 
If  the  Notes  Receivable  Dishonored  account  is  used,  the  debits  and 
credits  to  be  made  to  this  account  may  be  indicated  as  follows: 

NOTES  RECEIVABLE  DISHONORED 


Debit: 

At  the  time  of  dishonor  the  face  value 
of  any  note  receivable  dishonored 
(crediting  notes  receivable). 


Credit: 

With  the  face  value  of  any  note  dis- 
honored which  is  later  pajd  by  the 
maker  or  any  previous  indorser. 

With  the  face  value  of  any  dishon- 
ored note  for  which  a  new  note  js 
accepted. 

With  the  face  value  of  any  dishonored 
note  written  off  as  uncollectable 
(debiting  reserve  for  bad  debts,  or 
some  special  account,  such  as  "loss 
from  uncollectable  notes,"  accord- 
ing to  the  method  in  use  in  the 
business) . 


The  balance  of  the  Notes  Receivable  Dishonored  account  shows 
the  face  value  of  all  such  notes  still  held  in  the  hope  of  collection,  and 
is  shown  on  the  balance  sheet  as  an  asset,  subject  to  a  valuation  which 
must  be  made  after  careful  consideration  of  the  circumstances  in 
connection  with  each  such  note.  Protest  fees  and  other  charges 
incurred  in  connection  with  such  notes  will  be  charged  to  the  open 
account  of  the  maker  of  the  note.  If  ascertained  to  be  uncollectable, 
the  amount  of  such  charges  will  be  credited  to  Accounts  Receivable 
and  debited  to  Reserve  for  Bad  Debts. 

Accounts  with  fixed  assets.  In  chapter  vi  it  was  explained  that 
an  account  with  a  fixed  asset  should  be  debited  with  the  cost  value 
of  any  additions  to  that  asset,  and  credited  with  the  cost  value  of 
any  part  of  the  asset  destroyed,  sold,  or  otherwise  retired  from  use  in 
the  business.  It  was  also  pointed  out  that  while  the  asset  account 


200  PRINCIPLES  OF  ACCOUNTING 

showed  the  particular  asset  always  at  cost,  an  account  must  be  carried 
with  reserve  for  depreciation  on  the  fixed  asset  in  order  to  keep  a 
record  of  the  loss  in  its  value  which  is  estimated  to  have  occurred 
through  its  approach  to  the  end  of  its  useful  life. 

The  generally  accepted  basis  of  valuation  of  the  fixed  assets  for 
accounting  purposes,  then,  is  that  of  cost  less  accrued  depreciation. 
The  principles  involved  seem  logical  enough,  and  should  not  be 
difficult  to  understand,  and  the  student  should  by  this  time  be  quite 
familiar  with  the  manner  in  which  such  estimated  depreciation  is 
booked,  as  well  as  the  method  by  which  the  valuation  of  fixed  assets 
is  shown  on  the  balance  sheet. 

Charges  to  capital  versus  charges  to  revenue.  It  is  not  always  simple 
or  easy  to  carry  out  correctly  and  consistently  the  method  of  valu- 
ation indicated  in  the  foregoing  discussion.  The  difficulty  in  doing 
so  arises  from  two  main  sources:  (i)  the  difficulty  in  establishing  a 
correct  rate  for  estimating  depreciation;  (2)  the  difficulty  of  dis- 
tinguishing in  every  case  between  expenditures  which  add  to  the  value 
of  the  fixed  assets  and  those  which  are  properly  to  be  charged  as 
current  expenses. 

The  first  source  of  difficulty,  that  of  the  depreciation  rate,  is 
merely  a  matter  of  estimating  the  probable  useful  life  of  the  asset. 
Such  estimates  are  best  made  on  the  basis  of  experience  with  similar 
assets,  either  in  the  business  in  question  or  hi  other  like  business 
concerns.  An  adequate  record  of  the  life  and  performance  of  each 
unit  of  fixed  assets  used  in  the  business  will  aid  greatly  in  setting  future 
depreciation  rates  and  revising  existing  ones.  The  problem  involved 
here  may  well  receive  careful  and  detailed .  study  by  the  student  of 
accounting,  but  it  does  not  seem  wise  to  devote  more  time  to  it  at 
present. 

The  other  problem  mentioned,  that  of  the  distinction  between 
expenditures  for  current  expenses  and  those  for  additions  to  fixed 
assets,  must  also  be  considered  rather  briefly  here.  The  problem  may 
be  divided  into  two  parts,  as  follows:  (i)  What  expenditures  are 
properly  chargeable  to  the  original  cost  of  the  asset?  (2)  What 
expenditures  are  properly  chargeable  as  additions  to  the  value  of  the 
asset  ? 

As  regards  the  first  point,  the  original  cost,  it  may  be  illustrated 
by  indicating  a  few  of  the  typical  questions  of  this  nature  which  are 


CONSTRUCTION  OF  ACCOUNTS— ASSETS  261 

likely  to  come  up.  Thus  in  the  case  of  a  building  which  is  constructed 
by  the  business,  a  decision  would  have  to  be  made  whether  each  of  the 
following  expenditures  represented  a  part  of  the  cost  of  the  building 
or  a  current  operating  expense  of  the  business:  (i)  the  cost  of  a  pre- 
liminary survey  of  the  site;  (2)  payment  for  the  architect's  plans; 
(3)  interest  on  the  money  invested  in  materials  during  the  process 
of  construction;  (4)  insurance  of  the  materials  during  the  process 
of  construction.  Or,  in  purchasing  a  new  machine,  is  the  cost  of 
making  a  concrete  base  for  its  installation  and  the  expense  of  actually 
installing  it  to  be  charged  as  part  of  the  cost  of  the  asset  or  as  an 
operating  expense?  The  principle  that  governs  in  all  such  cases  is 
that  the  expenditure  should  be  treated  as  a  part  of  the  cost  of  the 
asset  if  it  is  an  expenditure  necessary  to  the  acquisition  of  the  asset 
in  a  working  condition.  On  this  basis  all  of  the  expenditures  cited 
would  be  properly  chargeable  to  the  asset  accounts. 

As  the  asset  continues  in  use,  certain  expenditures  will  be  neces- 
sary to  maintain  it  in  efficient  operating  condition.  The  building  will 
require  repairs  and  paint;  taxes  and  insurance  premiums  must  be 
paid  in  connection  with  its  use.  The  machine  or  the  office  equipment 
will  require  repairs  from  time  to  time,  as  well  as  certain  supplies 
necessary  to  their  operation,  such  as  oil,  waste,  and  the  like,  and  will 
necessitate  the  payment  of  taxes  and  insurance  premiums.  Expen- 
ditures of  this  type,  representing  as  they  do  part  of  the  necessary  cost 
of  using  the  asset  for  the  current  period,  are  pure  expense,  and  should 
be  charged  as  part  of  the  current  operating  expense  of  the  business. 
Such  expenditures  are  said  to  be  charges  to  revenue. 

Opposed  to  this  type  of  expenditures  is  the  class  of  expenditures 
which  add  to  the  investment  in  the  asset,  or  the  cost  value  of  the  asset. 
Such  expenditures  are  those  involved  in  the  construction  of  the  new 
building,  or  of  a  new  wing  to  the  old  building,  or  in  equipping  the 
machine  with  some  improved  device  that  adds  to  its  length  of  life  or 
productiveness.  Such  expenditures  are  said  to  be  charges  to  capital, 
since  they  represent  additions  to  the  long-time  investment  of  the 
proprietors. 

Unless  considerable  care  is  used,  expenditures  of  one  of  these 
classes  may  be  confused  with  those  of  the  other  class.  Thus  it  is  not 
difficult  to  consider  as  an  addition  to  the  asset  some  expenditure  which, 
if  its  effects  were  carefully  analyzed,  would  be  found  to  be  necessary 


262 


PRINCIPLES  OF  ACCOUNTING 


for  the  maintenance  of  the  asset,  and  not  an  addition  to  its  value. 
On  the  other  hand,  a  real  addition  to  investment  might  easily  be  mis- 
taken for  an  operating  expense.  This  distinction  between  capital 
and  revenue  is  an  important  one,  since  the  showing  of  the  current 
profits  for  each  period  and  the  showing  of  the  proprietorship  from 
time  to  time  depend  on  the  correctness  with  which  such  distinction 
is  made.  Thus  if  certain  expenditures  made  in  connection  with  the 
maintenance  of  a  fixed  asset,  and  properly  chargeable  to  revenue,  are 
wrongly  charged  to  capital,  or  "capitalized,"  not  only  will  the  assets, 
and  consequently  the  proprietorship,  be  overstated,  but  the  expenses 
for  the  period  will  be  understated  and  the  net  profit  therefore  over- 
stated by  that  amount. 

The  problem  of  distinguishing  between  capital  and  revenue 
charges  is  one  which  continually  faces  the  accountant.  There  is  no 
absolute  rule  to  be  laid  down  which  will  serve  as  a  formula  for  its 
solution.  It  is  merely  a  matter  of  careful  judgment  whether  the 
expenditure  in  question  represents  an  addition  to  the  investment  or 
whether  it  represents  an  operating  expense  of  the  current  period. 

The  debits  and  credits  to  a  fixed  asset  account  and  the  correspond- 
ing reserve  for  depreciation,  or  valuation  account,  may  be  indicated 
by  the  following  statement : 

BUILDINGS 


Debit: 
With  the  total  cost  of  all  buildings 

purchased  or  constructed. 
With  the  cost  of  any  additions  or 

improvements  which  add   to   the 

value  of  a  building. 


Credit: 
With  the  cost  value  of  any  buildings 

sold  or  otherwise  disposed  of. 
With  the  cost  value  of  any  part  of  a 

building    destroyed    or    otherwise 

retired  from  use. 


RESERVE  FOR  DEPRECIATION  OF  BUILDINGS 


Debit: 

With  the  excess  of  cost  value  over  the 
sale  price  or  salvage  value  of  any 
building  or  part  of  a  building  sold, 
destroyed,  or  otherwise  retired  from 
use  in  the  business  as  a  result  of  the 
operation  of  the  depreciation  factor. 


Credit: 

At  the  close  of  each  with  fiscal  period 
the  estimated  depreciation  on  build- 
ings for  that  period. 


As  previously  stated,  the  balance  in  the  fixed  asset  account  will 
show  the  cost  value  of  all  the  buildings  which  are  at  that  time  owned 


CONSTRUCTION  OF  ACCOUNTS— ASSETS  263 

and  used  by  the  business.  The  balance  of  the  valuation  account  will 
show  the  amount  of  depreciation  estimated  to  have  accrued  on  the 
buildings  then  in  use.  The  difference  between  the  two  balances 
represents  the  present  valuation  placed  on  the  buildings  for  purposes 
of  the  balance  sheet.  These  statements  hold  true  so  long  as  the 
depreciation  reserve  account  is  debited  only  with  the  amount  of  the 
realized  loss  of  value  which  results  from  depreciation  in  some  form. 
Thus  if  a  building  is  destroyed  by  fire,  storm,  or  other  unforeseen 
accidental  cause,  Reserve  for  Depreciation  of  Buildings  should  be 
debited  only  with  the  amount  of  the  estimated  depreciation  on  that 
building  up  to  the  time  of  its  destruction.  If  the  amount  of  insurance 
collected  is  less  than  the  excess  of  cost  over  estimated  depreciation, 
the  difference  should  be  charged  to  some  special  profit  and  loss 
account,  such  as  "Loss  from  Fire."  Assume  that  the  cost  of  a  new 
building  is  $100,000,  and  its  estimated  life  twenty  years.  Early  in 
the  second  year  of  its  life  a  wing  of  the  building,  the  original  cost  of 
which  is  $20,000,  is  destroyed,  and  only  $10,000  in  insurance  is 
collected.  At  the  end  of  the  first  year,  after  the  entry  had  been 
made  to  record  the  depreciation,  the  buildings  account  and  deprecia- 
tion reserve  account  would  appear  as  follows: 

BUILDINGS 


IOO.OOOOO 


RESERVE  FOR  DEPRECIATION  ON  BUILDINGS 


5,00000 


The  portion  of  estimated  accrued  depreciation  applicable  to  the 
wing  which  is  destroyed  is  $1,000.  The  entry  to  record  the  loss  might 
be  made  as  follows: 

Cash  (from  the  insurance  company)  \      $10,000.00 
Reserve  for  Depreciation  of  Buildings  1,000.00 

Loss  from  Fire 9,000.00 

Buildings $20,000.00 


264  PRINCIPLES  OF  ACCOUNTING 

The  two  accounts  under  discussion  would  then  appear: 
BUILDINGS 


100,000 

oo 

20,000 

00 

RESERVE  FOR  DEPRECIATION  ON  BUILDINGS 


* 

1,000 

00 

5,000 

oo 

Such  a  situation  might  be  handled  differently,  but  if  the  depre- 
ciation reserve  account  is  to  retain  its  character  as  a  valuation  account, 
the  foregoing  method  is  the  one  to  be  used. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  List  as  many  kinds  of  transactions  as  you  can  which  affect  the  account 
with  cash.    What  is  the  nature  of  the  voucher  which  occurs  in  connec- 
tion with  each  such  transaction  ? 

2.  Mention  as  many  kinds  of  transactions  as  you  can  which  affect  the 
account  with  accounts  receivable,  telling  whether  each  such  transaction 
results  hi  a  debit  or  credit  to  the  account.    What  kind  of  voucher  or 
vouchers  is  involved  in  each  ? 

3.  What  are  the  debits  and  credits  involved  when  a  business  receives  a 
customer's  check  hi  payment  for  an  invoice,  less  discount  for  cash  ? 

4.  On  June  5  the  Saunders  Company  sells  the  firm  of  Mears  &  Pierce  goods 
amounting  to  $700,  sending  them  a  sixty-day  trade  acceptance  with  the 
invoice,  according  to  previous  agreement.     Mears  &  Pierce  accept 
the  draft  and  return  it  to  the  seller.    What  entry  should  be  made  on 
the  books  of  the  Saunders  Company  ? 

5.  On  June  25,  the  Saunders  Company  discounts  this  trade  acceptance 
at  the  bank  at  6  per  cent.    What  entry  should  be  made  on  their  books 
for  this  transaction  ? 

6.  This  trade  acceptance  matures,  and  the  Saunders  Company  receives 
no  notice  from  the  bank  in  regard  to  it  and  are  therefore  relieved  from 
their  secondary  liability  as  drawer.     Should  any  entry  be  made  to 
record  this,  and  if  so,  what  would  the  entry  be  ? 

7.  Suppose  the  Saunders  Company  had  received  a  notice  from  the  bank 
that  the  acceptance  had  been  dishonored  by  non-payment,  and  that  the 
company  was  charged  by  the  bank  for  the  amount  of  the  acceptance 


CONSTRUCTION  OF  ACCOUNTS— ASSETS  265 

plus  a  three-dollar  protest  fee.  Is  there  more  than  one  possible  entry 
that  might  be  made  in  such  a  case  ?  If  so,  give  each  entry  that  might 
be  made.  Which  of  them  do  you  prefer,  and  why  ? 

8.  Assuming  the  acceptance  to  have  gone  to  protest  and  to  have  been  paid 
by  the  Saunders  Company,  with  the  charges,  what  entry  would  be  made 
on  the  books  of  that  company  if  Mears  &  Pierce  later  pay  them  the 
amount  of  the  acceptance  plus  the  charges? 

9.  On  December  31,  1919,  the  Saunders  Company  decides  to  allow  $125 
as  the  probable  amount  necessary  to  cover  their  losses  from  bad  debts 
for  the  period  just  ended.     Give  the  entry  to  show  this. 

10.  On  February  12,  1920,  the  Saunders  Company  discover  that  an  open 
account  carried  with  one  of  their  customers,  having  a  balance  at  that 
time  of  $50,  is  absolutely  uncollectable.  What  entry  will  they  make  to 
show  their  recognition  of  this  fact? 

n.  What  is  meant  by  charging  the  amount  of  a  given  expenditure  to 
capital  ?  By  charging  it  to  revenue  ?  What  difference  will  it  make  if 
an  expenditure  is  charged  to  capital  which  should  properly  have  been 
charged  to  revenue  ?  If  an  expenditure  properly  chargeable  to  capital 
is  charged  to  revenue  ? 

12.  Of  the  following  expenditures,  which  do  you  think  are  properly  charge- 
able to  capital  and  which  to  revenue  ? 

a)  Freight-in  on  machinery  purchased  for  use  in  factory. 

b)  Replacement  of  windovy  panes  broken  by  a  hail  storm. 

c)  Mechanics  wages  in  making  dies  for  use  in  manufacturing. 

d)  Replacement  of  roof  on  building. 

e)  Cost  of  construction  of  an  unloading  platform  at  warehouse. 
/)  Repairs  on  drayage  equipment. 

g)  Cost  of  a  partition  hi  an  office  building  constructed  at  request  of  new 

tenants. 
h)  Cost  of  demolishing  old  building  on  site  where  a  new  building  is  to 

be  constructed. 

REFERENCES  FOR  FURTHER  STUDY 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  chaps. 

vi,  xix-xxii. 

MITCHELL,  T.  W.,  Accounting  Principles,  chap,  xviii. 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  n,  chaps,  v,  vi, 

and  xi. 

STOCKWELL,  H.  G.,  Net  Worth  and  the  Balance  Sheet. 
WILDMAN,  J.  R.,  Principles  of  Accounting,  chaps,  xvi-xxvii. 
GREENBUNGEK,  LEO,  Financial  and  Business  Statements,  chaps,  vii,  viii, 

and  ix. 


CHAPTER  XXIII 

THE  CONSTRUCTION  AND  INTERPRETATION 
OF  ACCOUNTS— LIABILITIES 

Purpose  of  the  chapter.  In  chapter  viii  a  brief  discussion  was  given 
of  the  current  liabilities,  as  represented  by  accounts  payable  and  notes 
payable,  the  two  accounts  of  this  class  which  appear  hi  nearly  every 
business.  In  the  present  chapter  some  further  consideration  will  be 
devoted  to  the  accounts  with  current  liabilities,  and  also  to  the 
relatively  long-time  or  "fixed"  liabilities. 

Current  liabilities.  As  a  rule  the  current  liabilities  of  a  business 
consist  chiefly  of  its  liabilities  to  trade  creditors  and  to  the  bank. 
The  liabilities  to  trade  creditors  assume  two  forms,  open  accounts 
and  notes.  The  liability  to  the  bank  or  banks  is  ordinarily  repre- 
sented by  notes  outstanding.  There  may,  of  course,  be  liabilities 
on  open  account  to  other  than  trade  creditors,  and  there  may  be  notes 
due  to  others  beside  banks  and  trade  creditors.  Whether  separate 
accounts  will  be  carried  with  such  liabilities  depends  on  the  importance 
which  they  assume. 

Accounts  Payable.  Like  Accounts  Receivable,  Accounts  Payable 
is  usually  a  controlling  account.  It  shows  the  amount  owed  by  the 
business  to  its  creditors  on  open  accounts.  The  items  posted  to  this 
account  are  for  the  most  part  footings  of  special  columns  hi  the 
various  books  of  original  entry.  Accounts  with  individual  creditors 
are  carried  in  a  subsidiary  ledger,  and  may  be  posted  either  from  the 
items  entered  in  the  books  of  original  entry  or  directly  from  the 
vouchers  arising  out  of  transactions  with  creditors. 

The  kinds  of  transactions  affecting  this  account,  and  the  nature 
of  the  debits  and  credits  to  be  made  to  it,  may  be  indicated  as  in 
Accounts  Payable,  p.  267. 

The  balance  of  Accounts  Payable  account  is  always  on  the  credit 
side,  and  represents  the  total  amount  owed  by  the  business  on  open 
account  to  its  creditors.  At  any  tune  when  the  books  are  posted  to 
date,  this  balance  should  equal  the  total  of  the  credit  balances  hi  the 

266 


CONSTRUCTION  OF  ACCOUNTS— LIABILITIES 
ACCOUNTS  PAYABLE 


267 


Debit: 

With  cash  paid  to  creditors  in  pay- 
ment of  open  accounts. 

With  discounts  allowed  by  creditors 
for  cash  payments. 

With  the  invoice  value  of  goods  re- 
turned to  creditors. 

With  the  amount  of  any  credit  allowed 
the  business  by  a  creditor  for  freight 
or  other  charges  on  goods  returned. 

With  all  allowances  and  rebates 
allowed  by  creditors  for  any  reason 
whatever. 


Credit: 

With  the  total  of  all  invoices  of  goods 
purchased  on  account. 


individual  creditor's  accounts.  It  is  desirable  that  the  two  amounts 
should  be  compared  at  the  end  of  each  month,  or  as  often  as  the  books 
are  completely  posted  up  to  date;  and  where  a  discrepancy  is  found  to 
exist,  it  should  be  traced  to  its  source  and  the  necessary  corrections 
made. 

As  has  been  suggested,  there  may  be  a  considerable  number  of 
items  other  than  merchandise  which  are  purchased  on  open  account. 
It  is  sometimes  considered  desirable  to  keep  the  amount  of  liability 
incurred  for  such  items  separate  from  that  incurred  for  merchandise. 
In  such  a  case  two  accounts  would  be  carried  with  accounts  payable, 
one  of  which  would  be  called  "Accounts  Payable — Trade  Creditors," 
and  the  other  one  "Other  Accounts  Payable."  Such  a  separation  of 
accounts  payable  is  not  usually  considered  necessary. 

Notes  Payable.  The  nature  of  the  account  with  notes  payable  has 
already  been  explained  rather  fully.  This  account  shows  the  total  of 
the  face  of  all  the  notes  issued  and  time  drafts  accepted  by  the  busi- 
ness which  remain  unpaid  and  outstanding.  The  transactions 
affecting  this  account,  and  the  nature  of  the  debits  and  credits  to  be 
made  to  it,  may  be  shown  as  follows : 

NOTES  PAYABLE 


Debit: 

With  all  amounts  paid  in  settlement 
of  notes  or  drafts  outstanding. 


Credit: 

With  the  face  value  of  all  promissory 

notes  issued  by  the  business  to  its 

creditors. 
With  the  face  value  of  all  time  drafts 

accepted  by  the  business. 


268  PRINCIPLES  OF  ACCOUNTING 

The  balance  of  Notes  Payable  account  represents  at  any  time  the 
face  value  of  all  the  notes  and  drafts  outstanding  against  the  business 
at  that  time.  This  does  not  mean  that  only  one  account  with  notes 
payable  may  be  used,  if  the  need  for  a  division  or  classification  of 
such  notes  exists.  A  business  may  secure  credit  from  trade  creditors 
in  some  cases  by  giving  notes  or  trade  acceptances.  The  same  busi- 
ness may  borrow  money  from  the  bank  on  its  notes  to  enable  it  to  take 
the  discounts  offered  by  other  creditors  for  cash  payments.  In  such 
a  case  there  might  well  be  a  distinction  made  between  the  two  classes 
of  notes  outstanding,  according  to  the  class  of  creditors  who  hold  them. 
Such  a  distinction  would  involve  the  use  of  two  accounts  with  notes 
payable:  (i)  "Notes  Payable— Trade  Creditors,"  and  (2)  "Notes 
Payable — Banks." 

Occasionally  it  occur?  4'iat  money  is  borrowed  for  a  short  term 
from  someone  other  than  the  bank.  Such  borrowing  might  be  from 
a  partner  in  the  business,  an  officer  in  the  corporation,  or  some  friend 
or  relative  of  the  proprietor  or  member  of  the  firm  who  is  in  a  position 
to  make  the  business  a  short-time  loan  on  its  note.  In  such  a  case 
still  another  notes  payable  account  will  be  required.  The  title  of 
such  an  account  should  indicate  its  nature,  as  "Notes  Payable — 
Others,"  "Notes  Payable— Partners,"  or  "Notes  Payable— Officers." 
There  is  no  need  for  any  further  discussion  of  the  nature  of  such  an 
account,  or  of  the  debits  and  credits  to  be  made  to  it,  since  it  does  not 
differ  in  that  respect  from  the  general  account  with  notes  payable, 
which  has  already  been  discussed. 

Fixed  liabilities.  In  addition  to  the  lines  of  short-term  credit 
which  business  concerns  ordinarily  secure  from  their  trade  creditors 
and  from  the  banks,  it  is  often  found  desirable  to  secure  the  use  of 
funds  for  a  longer  period.  Such  funds  may  be  secured  from  additional 
investment  by  the  owners,  or  by  admitting  new  members  into  the 
owning  group,  as  by  admitting  an  additional  partner  who  would 
bring  in  a  certain  amount  of  investment,  or  by  issuing  additional 
capital  stock  to  outsiders,  in  the  case  of  a  corporation.  In  case  none 
of.  these  courses  seem  desirable,  the  money  may  be  secured  by  long- 
time borrowing  from  outsiders.  Such  borrowing  gives  rise  to  long- 
time or  fixed  liabilities,  certain  types  of  which  will  be  considered  at 
this  point. 


CONSTRUCTION  OF  ACCOUNTS— LIABILITIES 


269 


Mortgages  Payable.  Where  the  borrowing  concern  is  a  single 
proprietorship  or  a  partnership,  this  long-time  borrowing  is  usually 
done  by  means  of  an  interest-bearing  note,  secured  by  a  mortgage. 
This  means  that  a  formal  written  and  sealed  instrument  is  delivered 
to  the  lender,  giving  him  a  lien  for  the  amount  of  the  note  and  for  any 
cost  incurred  in  collecting  it,  on  certain  specified  property  of  the 
borrower.  Failure  on  the  part  of  the  borrower  to  pay  either  principal 
or  interest  when  due  gives  the  mortgage-note  holder  the  right  to 
foreclose  on  the  property  named  in  the  mortgage,  sell  it  at  auction, 
and  reimburse  himself  from  the  proceeds.  Long-time  borrowing  of 
this  sort  may  be  for  one  or  more  of  the  following  purposes:  (i)  in- 
creasing the  amount  of  fixed  assets;  (2)  refunding  outstanding  long- 
time liabilities;  (3)  increasing  the  amount  of  current  assets;  (4) 
funding  current  liabilities. 

The  account  representing  such  a  liability  as  the  one  just  described 
is  called  Mortgages  Payable.  The  nature  of  the  transactions  affecting 
this  account,  and  the  debits  and  credits  to  be  made  to  it,  may  be 
summarized  as  follows: 

MORTGAGES  PAYABLE 


Debit: 
With  all  payments  made  on  mortgage 

notes  payable. 
With  the  face  value  of  mortgage  notes 

payable  canceled  in  any  manner. 


Credit: 

With  the  face  value  of  all  long-time 
notes  issued  by  the  business  and 
secured  by  mortgages. 


The  balance  of  this  account  is  on  the  credit  side,  and  shows  the  face 
value  of  all  long-time  notes  secured  by  mortgages  which  are  outstand- 
ing against  the  business. 

Bonds  Payable.  If  the  borrowing  concern  is  a  corporation,  its 
long-time  borrowing  is  usually  accomplished  through  the  sale  of 
bonds.  Thus  when  it  has  been  decided  by  the  corporation  to  issue 
bonds  up  to  a  certain  amount,  a  formal  agreement  as  to  the  terms  of 
the  issue  is  made  with  some  bank  or  trust  company  whose  duty  it  is 
to  protect  the  interests  of  the  purchasers,  and  the  bonds  are  then 
offered  for  sale.  In  a  few  states  it  is  necessary  for  the  issuing  company 
to  secure  the  sanction  of  a  state  regulatory  body  of  some  sort  as  a 
prerequisite  to  offering  the  bonds  for  sale.  The  largest  of  such  issues 
are  usually  marketed  through  some  investment  company  or  bond 


270 


PRINCIPLES  OF  ACCOUNTING 


house,  or  through  a  syndicate  of  such  investment  banking  estab- 
lishments. 

The  bonds  are  printed  in  convenient  denominations,  ranging 
usually  from  $100  to  $10,000.  Each  bond  has  printed  on  it  a  brief 
statement  of  the  terms  of  the  contract  between  the  issuing  company 
and  the  investor.  This  contract  may  vary  widely  in  different  bond 
issues  with  regard  to  the  nature  of  the  security,  interest  rate,  con- 
vertibility into  other  securities  of  the  company,  redeemability,  etc. 
Thus  a  bond  issue  may  be  secured  by  a  mortgage  on  any  or  all  of 
the  fixed  assets  of  the  company,  or  by  no  mortgage  at  all.  The  only 
limits  to  the  variations  that  may  appear  in  such  contracts  are:  (i) 
what  the  law  will  permit,  and  (2)  what  the  investors  will  accept. 

The  interest  on  bonds  outstanding  is  a  fixed  charge  against  the 
issuing  company.  Upon  its  failure  to  make  payment  of  the  principal 
or  interest  when  due,  the  trustee  for  the  bondholders  may  act  to 
secure  a  foreclosure  on  the  property  of  the  company  subject  to  such 
foreclosure  by  the  terms  of  the  bond,  or  may  petition  the  courts  for 
the  appointment  of  a  receiver  for  the  company.  The -receiver  will 
take  charge  of  the  affairs  of  the  company  and  act  to  protect  the 
interests  of  the  bondholders  and  other  creditors.  Such  a  receivership 
may  involve  a  liquidation  of  the  company's  assets  and  a  closing  up 
of  its  affairs,  or  it  may  involve  a  reorganization,  for  the  purpose  of 
continuing  the  business  operations  in  such  a  manner  as  to  protect 
the  creditors'  interests. 

The  account  with  Bonds  Payable  shows  the  total  face  value  of  the 
company's  bonds  outstanding.  The  debits  and  credits  to  this  account 
are  as  follows: 

BONDS  PAYABLE 


Debit: 

With   the   face   value   of   all   bonds 
redeemed  or  otherwise  retired. 


Credit: 

With  the  face  value  of  all  bonds  sold 
or  otherwise  issued. 


Where  a  company  has  several  issues  of  bonds  outstanding,  a  separate 
account  will  usually  be  carried  in  the  ledger  for  each  such  issue. 
On  the  balance  sheet  of  the  issuing  company  the  amount  of  each  Such 
issue  may  be  shown  as  a  separate  item,  but  more  usually  only  one 
item  of  bonds  payable  is  shown,  this  representing  the  total  of  all  such 


CONSTRUCTION  OF  ACCOUNTS— LIABILITIES 


271 


issues  outstanding.  The  balance  of  any  account  with  bonds  payable 
represents  the  face  value  of  such  bonds  outstanding  at  the  time. 

Long-term  notes.  Corporations  often  issue  notes  for  periods 
which  are  relatively  short  as  compared  with  the  maturity  of  the 
average  bond,  but  longer  than  that  of  the  ordinary  note,  such  as  is 
given  to  the  bank  or  to  a  trade  creditor.  The  maturity  of  these  notes 
is  usually  from  one  to  five  years  from  the  time  of  their  issue.  The 
purpose  of  selling  such  notes  is  usually  to  secure  fixed  capital  at  a  time 
when  the  investment  market  is  not  considered  favorable  to  an  issue 
of  long-term  bonds,  it  being  the  expectation  that  bonds  will  later  be 
issued  to  take  their  place.  These  notes  are  not  different  from  bonds 
except  in  the  length  of  the  term  for  which  they  are  issued,  being 
issued  and  marketed  in  exactly  the  same  manner.  They  are  not 
usually  secured  by  mortgages,  but  depend  for  their  salability  on  the 
earning  power  and  general  credit  of  the  company. 

The  accounts  which  will  be  carried  with  such  notes  outstanding 
are  similar  to  the  account  with  any  issue  of  bonds,  except  that  the 
title  indicates  the  type  of  the  issue.  The  nature  of  such  an  account 
may  be  indicated  as  follows: 

1925  FIVE-YEAR  7  PER  CENT  GOLD  NOTES 


Debit: 

With  the  face  value  of  all  such  notes 
redeemed  or  otherwise  retired. 


Credit: 

With  the  face  value  of  all  such  notes 
sold  or  otherwise  issued. 


The  balance  of  such  a  notes  account  as  the  foregoing  shows  at  any 
time  the  face  value  of  all  such  notes  issued  and  outstanding  at  that 
time. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  In  a  well-managed  wholesale  business,  which  should  you  expect  to  be 
normally  the  larger  item,  Notes  Payable  or  Accounts  Payable  ?     Why  ? 

2.  Under  what  circumstances  should  you  carry  more'  than  one  account 
with  Notes  Payable  ?    What  purposes  would  be  served  by  such  sub- 
division of  this  account  ? 

3.  What  are  some  of  the  purposes  for  which  long-time  liabilities  are 
incurred  ? 

4.  In  what  forms  may  long-time  liability  be  incurred  ?    What  similarities 
have  these  various  forms  ?    What  difference  ? 


272  PRINCIPLES  OF  ACCOUNTING 

5.  The  A  Company  cannot  pay  the  interest  on  its  first  mortgage  bonds. 
What  course  of  action  is  open  to  the  bondholders  ?    What  factors 
will  determine  the  policy  which  they  should  follow  ? 

6.  In  1920  the  B  Company  has  the  alternative  of  issuing  fifteen-year 
mortgage  bonds,  yielding  6f  per  cent,  or  five-year  gold  notes  yielding 
7§  per  cent.    They  choose  to  issue  the  notes.    Why  ? 

7.  The    Consolidated    Gas    Company    has    outstanding    the    following 
securities: 

Equipment  trust  certificates 

Collateral  trust  bonds 

First  mortgage,  sinking  fund  gold  bonds 

Consolidated  and  refunding  mortgage  bonds 

Judging  from  the  titles,  what  should  you  suppose  to  be  the  distinguishing 
characteristics  of  each  of  these  issues  ? 

"8.  Assume  that  you  are  the  treasurer  and  auditor  of  the  Fabrikoid  Manu- 
facturing Company.  The  president  proposes  the  issue  of  $500,000  of 
ten-year  gold  notes,  for  the  purpose  of  liquidating  that  amount  of 
current  liabilities.  What  facts  would  you  require  before  you  could 
advise  him  with  regard  to  the  wisdom  of  this  proposal  ? 
9.  You  are  employed  by  a  bond  house.  You  are  asked  to  give  your 
opinion  of  the  wisdom  of  the  participation  by  your  house  in  a  new  issue 
of  bonds,  amounting  to  $3,000,000.  You  find  that  the  earnings  of  the 
issuing  company  for  the  past  five  years  have  not  been  very  satisfactory, 
but  that  the  bonds  are  secured  by  a  closed  first  mortgage  on  the  plant 
aud  equipment  of  the  company,  valued  at  $6,000,000.  This  plant  and 
eqvipment  is  new  and  highly  specialized.  What  do  you  think  your 
answer  would  be?  Is  there  any  additional  information  which  you 
would  require  ? 

10.  The  treasurer  of  a  company  talks  of  a  proposed  issue  of  five-year  notes 
for  the  purpose  of  "funding  current  liabilities."    Explain  and  comment. 


WILDMAN,  J.  R.,  Principles  of  Accounting,  chap.  xxix. 

STOCKWELL,  H.  G.,  Net  Worth  and  the  Balance  Sheet,  chaps,  xvii-xxii. 

GREENDLINGER,  LEO,  Financial  and  Business  Statements,  chap.  xiii. 


CHAPTER  XXIV 


THE  CONSTRUCTION  AND  INTERPRETATION  OF 
ACCOUNTS— PROPRIETORSHIP  ACCOUNTS 

Purpose  of  the  chapter.  From  the  beginning  of  the  course  it  has 
been  pointed  out  that  the  proprietorship  in  any  business  is  the  differ- 
ence between  the  total  assets  and  the  total  liabilities.  It  has  also 
been  shown  that,  since  this  proprietorship  or  net  worth  must  be 
reported  on  the  balance  sheet,  one  or  more  accounts  must  be  carried 
in  the  ledger  to  show  the  status  of  the  net  investment.  The  accounts 
maintained  for  this  purpose  will  differ  somewhat  in  their  titles,  their 
number,  and  their  construction,  according  to  the  form  of  organization 
under  which  the  business  is  conducted.  In  the  present  chapter 
consideration  will  be  given  to  the  kinds  of  proprietorship  accounts 
used  in  connection  with  the  three  main  forms  of  proprietorship  under 
which  business  is  conducted:  the  single  proprietorship,  the  partnership, 
and  the  corporation. 

Proprietorship  accounts  for  the  single  proprietor.  An  adequate 
discussion  of  the  proprietorship  accounts  ordinarily  used  in  a  single 
proprietorship  business  was  given  in  chapter  vi.  It  is  enough  to 
recall  that  in  such  a  business  the  two  accounts  with  proprietorship 
which  are  ordinarily  used  are:  (i)  proprietor,  capital  account; 
(2)  proprietor,  personal  account.  The  proprietor's  capital  account 
is  used  to  show  the  status  of  his  investment  in  the  business.  It  is 
debited  and  credited  as  follows: 

PROPRIETOR,  CAPITAL 


Debit: 

With  all  withdrawals  of  investment. 
With  the  amount  of  the  net  loss  for  the 

accounting  period,  in  case  such  a 

loss  exists. 
With  the  debit  balance  of  his  personal 

account  at  the  end  of  the  period. 


Credit: 

With  the  amount  of  the  proprietor's 
original  investment. 

With  any  additions  made  to  the 
original  investment. 

With  the  amount  of  net  profits  ascer- 
tained at  the  end  of  the  accounting 
period. 


273 


274 


PRINCIPLES  OF  ACCOUNTING 


The  balance  of  this  account,  as  already  indicated,  represents  the 
amount  of  the  proprietor's  net  investment  in  the  business  at  the  time. 
As  long  as  total  assets  exceed  total  liabilities,  this  will  be  a  credit 
balance.  If  assets  should  become  less  than  liabilities,  the  balance 
of  the  account  will  appear  on  the  debit  side  and  will  represent  a 
deficit. 

The  proprietor's  personal  account.  The  proprietor's  personal 
account  is  generally  used  to  show  the  amount  of  his  drawings  for  the 
period,  and  the  amount  subject  to  his  withdrawal  at  any  time.  As 
stated  in  chapter  viii,  the  proprietor  often  allows  himself  a  stated 
salary,  the  amount  of  which  is  debited  to  operating  expense  for  the 
period,  and  credited  to  his  personal  or  drawing  account.  His  per- 
sonal account  will  show  whether  he  has  drawn  more  or  less  than  the 
amount  of  his  salary  allowance.  If  this  account  shows  any  very 
considerable  overdraft  as  against  his  salary  allowance,  it  may  be 
closed  into  his  capital  account  at  the  end  of  a  period,  to  show  a  de- 
crease in  his  total  investment.  The  debits  and  credits  to  the 
proprietor's  personal  account  may  be  indicated  as  follows: 

PROPRIETOR,  PERSONAL 


Debit: 

With  amounts  drawn  by  the  owner 
against  anticipated  current  profits, 
or  against  a  stipulated  salary 
allowance. 

With  the  amount  of  the  credit  balance 
of  this  account  whenever  it  is 
desired  to  close  such  balance  into 
the  proprietor's  capital  account. 


Credit: 
With  the  periodical  allowance  made 

to  the  owner  as  salary. 
With  the  amount  of  the  debit  balance 
of  this  account  whenever  it  is  con- 
sidered desirable  to  close  it  into  the 
proprietor's  capital  account. 


The  balance  of  this  account  may  be  either  a  debit  or  a  credit 
balance.  If  a  credit,  it  shows  the  amount  of  the  proprietor's  salary 
allowance  which  is  still  undrawn.  If  a  debit,  it  shows  the  amount 
by  which  he  has  overdrawn  the  credit  from  this  source.  In  stating 
the  net  proprietorship  on  the  balance  sheet,  the  amount  of  the  balance 
of  the  personal  account  may  well  be  combined  with  that  of  the  capital 
account  to  show  the  proprietor's  total  net  ownership  at  that  time. 
This  combination  is  usually  effected  by  a  journal  entry  at  the  end  of 
the  fiscal  period,  closing  the  balance  of  the  personal  account  into  the 
capital  account. 


CONSTRUCTION  OF  ACCOUNTS— PROPRIETORSHIP  ACCOUNTS  275 

Proprietorship  accounts  in  the  partnership.  Where  there  is  more 
than  one  proprietor  and  the  business  is  carried  on  as  a  partnership, 
the  accounts  with  proprietorship  are  very  similar  to  those  just  dis- 
cussed except  that  there  must  be  a  separate  capital  account  and  a 
separate  personal  account  for  each  of  the  partners. 

Whether  the  partners  are  to  be  credited  periodically  with  a  stated 
salary,  and  what  the  amount  of  such  salary  shall  be  for  each  one, 
should  be  determined  by  the  terms  of  the  partnership  agreement. 
The  agreement  should  also  state  whether  each  partner  is  to  be  credited 
with  interest  on  the  amount  of  his  investment  before  a  division  of 
profits  is  made,  and  what  ratio  is  to  be  used  in  dividing  profits  or 
losses  among  the  partners.  The  provisions  of  the  agreement  of  each 
of  these  points  must  be  considered  before  any  disposition  of  net 
profits  is  made  at  the  end  of  an  accounting  period.  If  there  is  no 
formal  agreement,  or  if  the  agreement  is  silent  on  these  points,  then 
no  allowance  is  to  be  made  for  either  salary  or  interest,  and  profits 
and  losses  will  be  shared  equally  among  the  partners,  regardless  of 
the  amount  of  the  investment  of  each. 

The  nature  of  a  partner's  capital  account,  and  the  kinds  of 
changes  for  which  it  will  be  debited  and  credited,  may  be  indicated 
as  follows: 


JOHN  DOE,  PARTNER,  CAPITAL 


Debit: 

With  all  withdrawals  of  the  partner's 

investment. 
With  the  partner's  share  of  net  losses 

for  an  accounting  period. 


Credit: 

With  the  amount  of  the  partner's 
original  investment. 

With  all  additional  investments  made 
by  the  partner. 

With  the  amount  of  any  undrawn 
credit  balance  transferred  from 
the  partner's  personal  or  drawing 
account.  ' 

With  the  amount  of  any  net  profits 
accruing  to  the  partner  in  excess  of 
salary  and  interest  allowances, 
which  may  be  carried  directly  to 
the  partner's  capital  account. 


The  partner's  drawing  account.  The  personal  account  of  a  partner 
is  usually  known  as  his  drawing  account.  Like  the  personal  account 
of  the  single  proprietor,  it  is  debited  with  all  amounts  drawn  by  the 
partner  for  personal  use. 


276 


PRINCIPLES  OF  ACCOUNTING 


If  the  agreement  provides  for  salary  allowances,  these  will  be 
charged  to  expense  on  the  same  basis  as  any  other  salaries,  and  credited 
to  the  drawing  accounts  at  the  end  of  the  period,  along  with  any 
interest  allowances  that  may  be  made.  The  matter  of  interest 
allowances  is  one  which  is  discussed  in  nearly  every  accounting  text, 
but  seldom  if  ever  encountered  in  practice.  The  kind  of  transactions 
which  may  affect  a  partner's  drawing  account,  and  the  nature  of  the 
debits  and  credits  which  may  be  made  to  such  an  account,  may  be 
indicated  as  follows: 

JOHN  DOE,  PARTNER,  DRAWING  ACCOUNT 


Debit: 
With  amount  of  all  drawings  made  by 

the  partner  for  personal  use. 
With   any   undrawn   credit   balance 
transferred  from  this  account  to  the 
partner's   capital   account,   as   an 
addition  to  his  net  investment. 


Credit: 

With  periodical  allowance  for  part- 
ner's salary,  if  such  allowance  is 
provided.  x 

With  allowances  for  interest  on  the 
partner's  investment,  if  this  is 
provided  for  in  the  agreement. 

With  the  amount  of  any  debit  balance 
in  this  account  which  is  transferred 
to  the  partner's  capital  account 
to  show  a  reduction  in  his  net 
investment. 


If  the  balance  of  this  account  appears  on  the  credit  side,  it  shows 
the  amount  which  the  partner  is  still  entitled  to  withdraw  from  the 
business  without  affecting  his  capital  investment.  If  it  appears  as  a 
debit  balance,  it  shows  the  amount  by  which  he  has  overdrawn  his 
personal  allowances.  Any  considerable  credit  balance  which  accumu- 
lates in  this  account  may  be  transferred  to  the  partner's  capital 
account  hi  case  the  partnership  agreement  permits  and  the  partner  in 
question  so  desires.  Also,  the  amount  of  any  considerable  overdraft 
shown  by  a  debit  balance  hi  the  drawing  account  may  be  transferred 
to  his  capital  account  to  show  a  reduction  of  his  long-tune  investment, 
if  the  circumstances  make  this  seem  desirable.' 

On  the  balance  sheet,  the  balance  of  the  partner's  drawing  account 
is  added  to  that  of  his  capital  account  to  show  his  total  proprietorship 
if  the  drawing  account  has  a  credit  balance,  and  deducted  from  the 
balance  of  the  capital  account  if  the  drawing  account  shows  a  debit 
balance. 


CONSTRUCTION  OF  ACCOUNTS— PROPRIETORSHIP  ACCOUNTS  277 

Proprietorship  accounts  in  the,  corporation.  Something  of  the 
nature  of  the  corporate  form  of  organization  for  conducting  a  business 
enterprise  was  discussed  in  chapter  ii.  It  was  there  pointed  out  that 
the  corporation  is  a  legal  entity  entirely  apart  from  its  individual 
stockholders.  This  means  that  although  the  total  proprietorship 
of  the  stockholders  in  the  corporation  will  be  ascertained  in  exactly 
the  same  way  as  the  total  proprietorship  of  the  partners  or  the  indi- 
vidual proprietor,  it  will  not  be  stated  in  quite  the  same  way  in  the 
accounts  or  on  the  reports.  The  proprietorship  of  individual  owners 
will  not  be  shown  in  separate  ledger  accounts,  as  in  the  case  of  the 
single  proprietorship  or  the  partnership.  It  will  be  shown  rather  by 
a  few  general  accounts  hi  the  ledger,  while  a  subsidiary  record  known 
as  a  "stock  ledger"  furnishes  the  names  of  the  individual  stockholders 
and  the  number  of  shares  of  each  kind  of  stock  which  each  holds. 
The  proprietorship  accounts  which  are  carried  in  the  general  ledger  of 
the  corporation  are  typically  classified  as  follows:  (i)  Capital  Stock: 
(a)  Preferred  Capital  Stock,  (b)  Common  Capital  Stock;  (2)  Surplus 
(general);  (3)  Reserves  (special  appropriations  of  surplus).  These 
accounts  will  be  taken  up  for  discussion  in  the  order  in  which  they  are 
listed  above. 

Capital  stock.  Contributions  of  capital  by  the  prospective  pro- 
prietors in  the  corporation  take  the  form  of  the  purchase  of  shares  of 
stock.  At  the  time  when  the  corporation  is  organized  authorization 
is  secured  from  the  proper  authorities  for  the  issue  of  a  certain  number 
of  shares  of  stock,  each  such  share  usually  having  a  definite  par  value, 
although  this  is  not  always  the  case.  Part  or  all  of  these  shares  are 
then  subscribed  for,  and  are  issued  in  exchange  for  cash  or  other 
property  paid  to  the  corporation.  If  the  authorized  stock  is  not  all 
issued  at  the  outset,  the  remainder  may  be  issued  at  a  later  time,  when 
further  investment  is  required,  or  when  the  market  is  more  favorable. 
Also,  authorization  may  be  secured  for  stock  issues  in  addition  to 
those  originally  contemplated. 

In  case  the  stock  has  a  definite  par  value,  it  may  be  issued  (i)  in  ' 
exchange  for  cash  or  other  property  equal  in  value  to  the  par  value  of 
the  stock  (issued  at  par);  (2)  in  exchange  for  property  whose  value  is 
less  than  the  par  value  of  the  stock  (issued  at  a  discount) ;  (3)  in  ex- 
change for  property  whose  value  is  hi  excess  of  the  par  value  of  the 
stock  (issued  at  a  premium). 


278 


PRINCIPLES  OF  ACCOUNTING 


Regardless  of  the  value  of  the  assets  received  in  exchange  for  the 
stock  issued,  if  this  stock  has  a  par  value,  the  capital  stock  account 
will  always  show  the  exact  par  value  of  the  shares  of  stock  which  are 
issued  and  outstanding.  It  is  desirable  to  preserve  in  this  account 
the  par  of  the  stock  issued,  not  only  for  legal  reasons,  but  because  it 
serves  as  the  basis  for  dividends,  and  enables  a  reader  of  the  balance 
sheet  to  calculate  the  amount  of  ownership  represented  by  a  single 
share  of  a  given  par  value.  The  nature  of  the  account  with  capital 
stock,  and  of  the  debits  and  credits  to  be  made  to  that  account,  may 
be  indicated  as  follows: 

CAPITAL  STOCK 


Debit: 

With  the  par  value  of  all  shares  of 
stock  redeemed  by  the  corporation, 
or  otherwise  retired. 


Credit: 

\Yith  the  par  value  of  all  shares  of 
stock  issued  by  the  corporation. 


The  balance  of  this  account  always  appears  on  the  credit  side,  and 
represents  the  par  value  of  the  stock  then  outstanding. 

Contracts  entered  into  between  the  corporation  and  the  stock- 
holders may  be  of  various  kinds.  Thus  a  corporation  may  issue  not 
only  common  stock,  entitling  the  holders  to  certain  specified  rights, 
but  also  preferred  stock,  which  enjoys  certain  preferences  as  to  divi- 
'dends,  and  in  many  cases  in  its  claim  on  the  assets  of  the  company 
in  case  of  dissolution.  Also,  there  may  be  more  than  one  class  of 
common,  and  more  than  one  class  of  preferred,  stock,  the  classification 
in  each  case  depending  on  the  terms  of  the  contract.  Where  there  is 
more  than  one  class  of  stock  outstanding,  an  account  will  be  carried 
in  the  general  ledger  with  each  such  class.  Thus  the  capital  stock 
accounts  of  a  given  corporation  might  be  classified  as  follows:  First 
Preferred  Capital  Stock;  Second  Preferred  Capital  Stock;  First 
Common  Capital  Stock;  Second  Common  Capital  Stock.  Since  each 
such  account  is  only  a  subdivision  of  the  capital  stock  account,  its 
nature  and  the  debits  and  credits  to  be  made  to  it  are  in  no  way 
different  and  do  not  need  to  be  repeated  at  this  point. 

Discount  on  stock.  In  case  the  stock  is  originally  issued  for  assets 
whose  value  is  less  than  the  par  of  the  stock,  it  will  be  necessary  to 
carry  a  valuation  account  to  show  the  amount  by  which  the  par  of  the 
capital  stock  outstanding  exceeds  the  actual  investment.  Such  an 


CONSTRUCTION  OF  ACCOUNTS— PROPRIETOR  SHIP  ACCOUNTS  279 


account  is  called  Discount  on  Stock,  and  debits  and  credits  are  to  be 
made  to  it  as  follows: 

DISCOUNT  ON  STOCK 


Debit: 

At  time  stock  is  issued  with  excess  of 
par  of  stock  issued  over  value  of 
assets  received. 


Credit: 

With  amount  of  current  net  profits 
transferred  to  this  account  to  reduce 
its  balance. 

With  amount  of  any  portion  of  sur- 
plus transferred  to  this  account  to 
reduce  its  balance. 


The  balance  of  such  an  account  will  be  a  debit,  and  represents  the 
excess  of  the  par  value  of  the  stock  outstanding  over  the  actual  invest- 
ment represented  by  that  stock.  It  should  be  written  off,  as  indicated 
above,  by  the  appropriation  of  net  earnings  for  that  purpose. 

The  issue  of  stock  at  a  premium  will  be  considered  under  the 
discussion  of  surplus. 

Surplus.  If  the  operations  of  the  corporation  are  successful,  net 
profits  will  be  earned.  If  these  profits  are  not  all  withdrawn  (and 
usually  they  are  not),  the  proprietorship  of  the  corporation  will 
increase  to  an  amount  in  excess  of  the  par  of  the  stock  outstanding. 
This  increased  proprietorship  cannot  be  reflected  by  the  capital  stock 
account,  which  shows  only  the  par  of  the  stock.  Such  an  excess  of 
total  proprietorship  over  capital  stock  is  shown  by  a  surplus  account. 
The  nature  of  the  debits  and  credits  to  be  made  to  the  surplus  account 
may  be  shown  as  follows: 

SURPLUS 


Debit: 

With  the  amount  of  all  appropriations 
made  of  surplus  for  any  purpose, 
such  as  dividends,  reserves,  and  the 
like. 

With  the  amount  of  any  recognized 
decrease  in  proprietorship,  resulting 
from  operating  of  other  losses. 


Credit: 

At  the  end  of  the  fiscal  period  with 
amount  of  all  current  net  profits 
not  otherwise  appropriated. 


The  balance  of  this  account  must  always  be  on  the  credit  side,  and 
represents  the  amount  by  which  the  net  investment  not  appropriated 
for  any  special  purpose  exceeds  the  par  value  of  the  capital  stock 
outstanding.  If  for  any  reason  the  net  proprietorship  falls  below  the 
par  of  the  stock  outstanding,  the  surplus  account  will  be  closed  out, 
and  an  account  of  the  opposite  nature,  headed  "Deficit,"  or  some  such 
appropriate  title,  will  be  set  up  to  show  the  deficiency. 


280 


PRINCIPLES  OF  ACCOUNTING 


Where  stock  is  issued  at  a  premium,  the  amount  by  which  the 
original  investment  exceeds  the  par  value  of  the  stock  issued  is  usually 
entered  in  a  special  surplus  account,  known  as  Capital  Surplus,  or 
Contributed  Surplus.  The  analysis  of  this  account  may  be  indicated 

as  follows: 

CAPITAL  SURPLUS 


Debit: 

With  the  amount  of  any  appropriation 
made  of  this  surplus,  such  as  an 
offset  to  stock  later  issued  at  dis- 
count. 


Credit: 

With  the  amount  by  which  assets 
received  in  exchange  for  capital 
stock  issued  exceed  the  par  value 
of  such  stock. 


The  balance  of  this  surplus  account  will  be  on  the  credit  side,  and 
represents  the  excess  of  capital  contributed  by  the  stockholders  over 
the  par  value  of  the  stock  issued.  The  amount  of  such  surplus, 
representing  as  it  does  original  contributions  of  capital,  is  not  ordi- 
narily considered  to  be  available  for  distribution  as  dividends. 

Proprietorship  reserves.  In  discussing  the  surplus  account  it  was 
stated  that  the  balance  of  that  account  represents  the  amount  of  the 
surplus  which  is  not  appropriated  for  any  special  purpose.  Whenever 
any  portion  of  surplus  or  of  current  net  profits  is  appropriated  for  a 
particular  purpose,  the  amount  so  appropriated  is  transferred  to  the 
credit  of  some  proprietorship  reserve  account.  Examples  of  accounts 
with  such  proprietorship  reserves  are :  Reserve  for  Addition  to  Plant, 
Reserve  for  Redemption  of  Bonds,  and  Sinking  Fund  Reserve.  Such 
accounts  are  here  designated  as  proprietorship  reserves  in  order  to 
distinguish  them  from  the  so-called  "reserve"  accounts  which  really 
represent  valuations  on  assets,  or  deductions  from  the  balance  carried 
in  some  asset  account.  Such  valuation  reserve  accounts  are  Reserve 
for  Bad  Debts  and  Reserve  for  Depreciation. 

Reserve  for  Addition  to  Plant  may  be  taken  as  representative  of 
proprietorship  reserve  accounts.    The  nature  of  this  account,  and  the 
debits  and  credits  to  be  made  to  it  may  be  indicated  as  follows: 
RESERVE  FOR  ADDITION  TO  PLANT 


Debit: 

With  the  value  of  assets  applied  to  the 
accomplishment  of  the  purpose  for 
which  the  reserve  was  appropriated 
(to  transfer  such  amount  back  to 
the  general  surplus  account). 


Credit: 

With  the  amount  of  surplus  or  current 
net  profits  appropriated  for  the 
purpose  indicated  by  the  title  of  the 
account 


CONSTRUCTION  OF  ACCOUNTS— PROPRIETORSHIP  ACCOUNTS  281 

The  balance  of  such  a  reserve  account  shows  the  amount  of  that  part 
of  the  total  proprietorship  which  has  been  appropriated  to  the  desig- 
nated purpose  and  which  has  not  yet  been  applied  to  the  accomplish- 
ment of  that  purpose.  Such  a  balance  will  appear  on  the  credit  side 
of  the  account. 

Proprietorship  reserves  are  to  be  considered  as  a  portion  of  surplus, 
but  as  a  portion  appropriated  for  a  specific  purpose  and  therefore  not 
available  for  dividends.  The  capital  stock  account  or  accounts,  the 
general  surplus  account,  and  the  proprietorship  reserve  accounts  are 
to  be  taken  together  to  show  the  total  of  the  proprietorship  in  the 
corporation,  and  should  therefore  be  grouped  together  on  the  balance 
sheet  for  this  purpose. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  What  is  the  purpose  of  the  proprietor's  capital  account?    What 
entries  may  be  made  to  this  account  ? 

2.  What  transactions  would  affect  the  personal  account  of  the  proprietor  ? 
How  should  you  show  the  balance  of  this  account  on  the  balance  sheet  ? 

3.  Are  the  differences  between  the  proprietorship  accounts  of  the  partner- 
ship and  those  of  the  single  proprietor  marked  enough  to  merit  dis- 
cussion ? 

If  so,  what  are  these  differences,  and  why  do  they  exist  ? 

4.  What  is  there  about  the  nature  of  a  corporation  that  causes  its  pro- 
prietorship accounts  to  be  different  from  those  of  the  partnership  of  the 
single  proprietor  ? 

5.  Why  should  the  amount  of  capital  stock  outstanding  always  be  shown  at 
par  ?    When  should  there  be  more  than  one  class  of  capital  stock  ? 

6.  What  is  the  purpose  of  the  account  with  discount  on  stock?    How 
should  it  appear  on  the  balance  sheet  ? 

7.  What  record  is  made  when  stock  is  issued  above  par?    How  will  this 
fact  be  shown  on  the  balance  sheet  ? 

8.  What  is  the  nature  of  the  surplus  account  ?    Could  this  account  have 
a  debit  balance  ?    Why,  or  why  not  ?    Can  you  identify  any  particular 
group  of  assets  with  the  surplus  account  ? 

9.  What  is  a  reserve  ?    Is  there  more  than  one  kind  of  reserve  account  ? 
If  so,  what  are  the  distinguishing  features  of  each  kind  ?    Which  is  more 
properly  known  as  a  "  reserve  "  account  ? 

10.  Must  a  reserve  account  be  identified  with  a  particular  group  of  assets  ? 
May  it  be  so  identified?  Under  what  circumstances. would  this  be 
desirable  ? 


282  PRINCIPLES  OF  ACCOUNTING 

11.  Name  as  many  so-called  "reserve"  accounts  as  you  can,  and  discuss 
briefly  the  nature  and  purpose  of  each. 

12.  You  are  engaged  to  audit  the  accounts  of  the  X  Company,  which  has 
been  in  operation  for  one  year.    You  find  that  the  accounts  show  capital 
stock  outstanding  (all  common)  to  be  $500,000,  and  surplus  account  has 
a  balance  of  $150,000.     Upon  inquiry  you  learn  that  $100,000  of  this 
was  contributed  by  the  stockholders,  who  subscribed  to  the  stock  at  a 
premium  of  20  per  cent.     Should  you  suggest  any  modification  of  the 
accounts  ?    If  so,  give  the  journal  entry  required  to  put  these  modifi- 
cations into  effect.    Justify  any  recommendation  which  you  would 
see  fit  to  make  in  regard  to  this  matter. 

REFERENCES  FOR  FURTHER  STUDY 
WILDMAN,  J.  R.,  Principles  of  Accounting,  chaps,  xxx,  xxxi,  xxxii. 
HATFIELD,  H.  R.,  Modern  Accounting,  chaps,  viii,  ix,  xiii,  xiv. 
DICKINSON  A.  L.,  Accounting  Practice  and  Procedure,  pp.  127-33. 
STOCKWELL,  H.  G.,  Net  Worth  and  the  Balance  Sheet,  chaps,  xxiii-xxvi. 
GREENDLINGER,  LEO,  Financial  and  Business  Statements,  chaps,  xii,  xiv,  xv. 

LABORATORY  EXERCISE  NO.  33 

W.  C.  Harvey  has  decided  to  put  in  a  stock  of  furniture  along  with  his 
hardware.  He  does  not  think  that  it  would  be  worth  while  to  attempt  any 
division  ot  the  operating  expenses  of  the  business  with  regard  to  whether 
they  are  chargeable  against  the  income  from  the  sale  of  hardware  or  of 
furniture,  but  he  does  wish  to  know  the  gross  profit  from  each  of  the  two 
classes  of  sales  separately.  This  means  that  you  will  need  to  carry  two  in- 
ventory accounts,  two  purchases  accounts,  two  sales  accounts,  two  accounts 
with  in-freight,  two  with  sales  returns  and  allowances,  and  two  with  pur- 
chase returns  and  allowances.  The  additional  analysis  thus  required  will 
make  necessary  some  modification  in  the  form  and  number  of  the  books  of 
original  entry.  In  addition  to  the  general  journal,  which  is  always  indis- 
pensable, the  books  of  original  entry  to  be  used  hi  this  exercise  may  be 
outlined  as  follows: 

Purchases  Journal.  Use  columnar  journal  paper,  and  provide  columns 
as  follows:  (i)  Date,  (2)  Name,  (3)  Address,  (4)  Terms,  (5)  Invoice  Number, 
(6)  Folio,  (7)  Accounts  Payable,  Cr.,  (8)  Hardware  Purchases,  Dr,,  (9)  Fur- 
niture Purchases,  Dr.  All  purchases  of  merchandise,  on  any  terms  what- 
ever, will  be  entered  into  this  journal,  the  amount  of  the  invoice  being 
credited  in  each  case  to  Accounts  Payable.  In  case  the  purchase  is  really 
paid  for  immediately  by  cash  or  by  a  note,  the  payment  would  be  recorded 
elsewhere  and  posted  to  the  debit  of  Accounts  Payable.  The  posting  from 
this  form  of  purchases  journal  is  the  same  as  that  for  the  form  used  in  the 
last  exercise,  except  that  there  are  two  purchases  accounts  instead  of  one. 


CONSTRUCTION  OF  ACCOUNTS— PROPRIETORSHIP  ACCOUNTS  283 

Purchase  Returns  and  Allowances  Journal.  Use  the  same  kind  of  paper, 
with  columns  as  follows:  (i)  Date,  (2)  Name,  (3)  Address,  (4)  Terms, 

(5)  Invoice  Number,  (6)  Folio  Number,  (7)  Accounts  Payable,  Dr.,  (8)  Pur- 
chase Returns  and  Allowances  (Hardware),  Cr.,  (9)  Purchase  Returns  and 
Allowances  (Furniture),  Cr.    The  posting  procedure  for  this  journal  is  the 
same  as  for  the  purchases  journal,  except  that  the  debits  and  credits  are  in 
each  case  directly  reversed. 

Sales  Journal.  Use  columnar  journal  paper.  Provide  columns  as 
follows:  (i)  Date,  (2)  Name,  (3)  Address,  (4)  Terms,  (5)  Invoice  Number, 

(6)  Folio  Number,  (7)  Accounts  Receivable,  Dr.,  (8)  Cash,  Dr.,  (9)  Hard- 
ware Sales,  Cr.,  (10)  Furniture  Sales,  Cr.    The  "Cash,  Dr."  column  is 
included  for  purposes  of  analysis,  and  to  make  this  journal  balance.    Its 
footing  is  not  to  be  posted,  since  all  debits  to  cash  will  be  included  in  the  cash 
book.    Otherwise  the  posting  is  as  indicated  by  the  form  of  the  journal. 

Sales  Returns  and  Allowances  Journal.  Columnar  journal  paper. 
Columns  as  follows:  (i)  Date,  (2)  Name,  (3)  Address,  (4)  Terms,  (5)  Invoice 
Number,  (6)  Folio  Number,  (7)  Accounts  Receivable,  Cr.,  (8)  Cash,  Cr., 

(9)  Hardware  Sales  Returns  and  Allowances,  Dr.,  (10)  Furniture  Sales 
Returns  and  Allowances,  Dr.    Here  again  the  "  Cash,  Cr. "  column  is  not 
to  be  posted.    All  cash  refunds  for  returns  and  allowances  are  to  be  shown 
in  the  cash  book,  as  well  as  all  cash  sales.    The  credits  to  Sales,  and  the 
debits  to  Sales  Returns  and  Allowances,  will  not  be  posted  from  the  cash 
book,  but  from  the  sales  journal  and  the  returns  and  allowances  journal. 
In  the  cash  book  a  check  will  be  placed  in  the  folio  column  opposite  each 
such  item,  to  indicate  that  it  is  not  to  be  posted  from  that  book. 

Cash  Receipts  Journal.  Use  columnar  journal  paper.  Columns  as 
follows:  (i)  Date,  (2)  Account  Credited,  (3)  Explanation,  (4)  General 
Ledger  Folio,  (5)  Accounts  Receivable  Folio,  (6)  Sundry  Accounts,  Cr., 

(7)  Accounts  Receivable,  Cr.,  (8)  Sales,  Cr.,  (9)  Cash,  Dr.    In  the  column 
for  "Sundry  Accounts,  Cr."  will  be  entered  the  credits  to  all  accounts  for 
which  special  columns  have  not  been  provided.    Each  of  the  credits  in  this 
column  must  be  posted  to  the  general  ledger  separately,  entering  the  folio 
number  in  the  "General  Ledger  Folio"  column.    As  was  previously  ex- 
plained, the  footing  of  the  "Sales,  Cr."  column  is  not  to  be  posted.    The 
rest  of  the  posting  follows  the  procedure  already  familiar  to  the  student. 

Cash  Disbursements  Journal.  Use  columnar  journal  paper.  Columns 
as  follows:  (i)  Date,  (2)  Account  Debited,  (3)  Explanation,  (4)  General 
Ledger  Folio,  (5)  Accounts  Payable  Folio,  (6)  Sundry  Accounts,  Dr.,  (7) 
Accounts  Payable,  Dr.,  (8)  Cash  Discount  on  Purchases,  Cr.,  (9)  Cash,  Cr., 

(10)  Delivery  Expense,  Dr.,  (n)  Office  Expense,  Dr.    The  "Sundry  Ac- 
counts, Dr."  column  in  this  form  is  used  in  the  same  manner  as  that  indi- 
cated in  the  discussion  of  the  corresponding  column  in  the  cash  receipts 
journal.    The  posting  to  the  accounts  debited  in  this  column,  and  the 


284  PRINCIPLES  OF  ACCOUNTING 

posting  to  the  individual  accounts  in  the  creditor's  ledger,  is  the  only  detailed 
posting  to  be  made  from  this  journal.  The  footings  of  all  the  other  columns 
are  to  be  posted  as  indicated  by  the  column  headings. 

TRANSACTIONS  FOR  MAY 

May  i 

Received  a  check  from  J.  Gunderson  for  $225.00,  the  amount  of  his 
account  to  date.  Received  from  Boutell  Furniture  Co.,  St.  Paul,  an  invoice 
for  a  shipment  of  furniture,  $900.00,  2/io/n/6o.  (Open  separate  account 
with  furniture  purchases.)  Paid  freight  on  this  shipment,  $25.00.  (Also 
open  separate  account  for  in-freight,  furniture.)  Cash  sales,  hardware, 

$95-00. 

May  2 

Sold  William  Gibson  on  account  $205.00,  hardware.  Sold  Charles 
Robinson  hardware  on  account,  $95.00.  Paid  rent  of  store  for  May, 
$125.00.  Cash  sales  hardware,  $72.00. 

May  3 

H.  Greiner  paid  his  account  in  full  to  date,  $294. 50.  Paid  $50.00  for 
stamps.  Paid  bills  as  follows:  light,  $9.40;  telephone,  $6.00;  telegrams, 
$8 . 90.  Cash  sales,  hardware,  $65 .  oo. 

May  4 

Sold  Howard  Jones  furniture  on  account,  $250.00.  Sold  Andrew 
Anderson  hardware  on  account,  $100.00.  Paid  Hibbard,  Spencer,  Bart- 
lett's  invoice  of  April  26,  less  discount.  Paid  salaries,  same  as  last  week 
(Week  ended  April  27.)  Withdrew  $40.00  for  personal  use.  Cash  sales, 
hardware,  $60.00;  furniture,  $40.00. 

May  6 

Sold  Thomas  Dodge  hardware  on  account,  $140 .  oo.  Sold  John  Wright, 
furniture  on  account,  $65.00.  Received  invoice  from  Marshall- Wells 
Hardware  Co.,  $350.00,  2/io/n/3o.  Paid  freight  on  this  shipment,  $7. 50. 
Cash  sales,  hardware,  $65.00. 

May  7 

Received  from  Simmons  Hardware  Co.  notification  of  a  credit  for  goods 
returned  to  them  out  of  invoice  of  April  29,  $95.00.  Sold  Charles  Clayton 
furniture  on  account,  $75 .  oo.  Sold  Jacob  Gunderson  hardware  on  account, 
$80.00.  Cash  sales,  hardware,  $53.00;  furniture,  $35.00. 

May  8 

Received  invoice  from  New  England  Furniture  Co.,  Detroit,  Mich., 
$450.00,  2/io/n/6o.  Paid  $12.00  freight  on  this  shipment.  Sold  E.  F. 


CONSTRUCTION  OF  ACCOUNTS—  PROPRIETORSHIP  ACCOUNTS  285 

Hughes   furniture   on   account,   $95.00.     Cash   sales,  hardware,  $67.00; 
furniture,  $00.00. 

May  g 

Paid  balance  due  on  Simmons  Hardware  Co.'s  invoice  of  April  29,  less 
discount.  Sold  H.  Rowe  hardware,  $i 25 .  oo,  on  account.  Cash  sales,  hard- 
ware, $55.00;  furniture,  $25.00. 

May  10 

Discounted  our  sixty -day  note  for  $1,000.00  at  the  bank,  at  6  per  cent. 
Sold  Charles  Clayton  furniture  on  account,  $110.00.  Paid  for  advertising 
in  the  local  paper,  $45 .  oo.  Cash  sales,  hardware,  $87 .  oo;  furniture,  $24 .  oo, 

May  ii 

Paid  salaries  for  the  week,  including  an  additional  sales  clerk  at  $22.00. 
Withdrew  $50.00  for  personal  use.  Paid  Boutell  Furniture  Co.'s  invoice 
of  May  i,  less  discount.  Sold  Howard  Strong  hardware  on  account, 
$85.00.  Cash  sales,  hardware,  $67.00;  furniture,  $30.00. 

May  13 

Received  invoice  from  Huron  Supply  Co.  for  wrapping  paper  and  twine, 
$125.00,  net.  Paid  a  garage  bill  of  $17.00.  Sold  John  Wright  hardware 
on  account,  $40.00.  Charles  Robinson  paid  his  account  to  date.  Cash 
sales,  hardware,  $78.00;  furniture,  $24.00. 

May  14 

Sold  Charles  Robinson  hardware  on  account,  $45 .  oo.  Paid  for  adver- 
tising circulars,  $25.00.  Paid  $5.00  for  their  distribution.  Cash  sales, 
hardware,  $60.00;  furniture,  $41.00. 

May  15 

Charles  Clayton  made  a  claim  that  certain  goods  purchased  by  him 
on  May  lowere  inferior  in  quality.  He  was  allowed  $15.00.  Sold  James 
Freeman  furniture  on  account,  $90.00.  Cash  sales,  hardware,  $70.00; 
furniture,  $15.00. 

May  16 

Sold  D.  W.  Kelly  hardware  on  account,  $15.60.  Sold  C.  E.  Pierce 
furniture  on  account,  $300.00.  Cash  sales,  hardware,  $105.00.  Paid 
Marshall- Wells  Hardware  Co.'s  invoice  of  May  6,  less  discount. 

May  17 

Received  a  memorandum  from  the  New  England  Furniture  Co.,  allow- 
ing our  claim  for  $15.00  for  defective  goods,  $75.00  for  goods  returned. 
Sold  H.  Greiner  hardware  on  account,  $120.00.  Cash  sales,  hardware, 
$67.50;  furniture,  $32.00. 


286  PRINCIPLES  OF  ACCOUNTING 

May  18 

Paid  balance  on  New  England  Furniture  Co.'s  invoice  of  May  8,  less 
discount.  Withdrew  $50.00  for  personal  use.  Cash  sales,  hardware, 
$83.00;  furniture,  $37.50. 

May  20 

Paid  salaries,  same  as  last  week.  Received  invoice  from  Lindell  and 
Evans,  Grand  Rapids,  Mich.,  for  furniture,  $375.00,  2/io/n/3o.  Sold 
E.  F.  Hughes  hardware  on  account,  $47 . 50.  Cash  sales,  hardware,  $68.  oo; 
furniture,  $17.50. 

May  21 

Sold  Herman  Rowe  builders'  hardware,  on  account,  f.o.b.  his  station, 
$250.00.  Paid  freight  on  the  same,  $3.00.  Paid  $4.50  for  repairs  on 
typewriter.  -Cash  sales,  hardware,  $74.00;  furniture,  $45 . oo. 

May  22 

Bought  stationery  amounting  to  $18.00.  Peter  Henderson  paid  his 
account  in  full.  Sold  James  Freeman  hardware  on  account,  $35 .  oo.  Cash 
sales,  hardware,  $56.00;  furniture  $38.00. 

May  23 

Received  of  Western  Supply  Co.  invoice  for  additional  showcases, 
$75.00,  n/i5.  Paid  $7.50  for  installation  of  same,  and  freight  on  the 
shipment,  $6.00.  Sold  Adam  Jones  hardware  on  account,  $48.00.  Cash 
sales  hardware,  $72.00. 

M ay  24 

Cash  sales,  hardware,  $37. 50;  furniture,  $25.00. 

May  25 

Received  invoice  for  hardware  from  W.D.Allen  Co. ,$250.  oo,  2/io/n/3o. 
Paid  salaries  same  as  last  week.  Withdrew  $50.  oo  for  personal  use.  Cash 
sales,  hardware,  $87.50;  furniture,  $35.00. 

May  27 

Refunded  $25.00  on  furniture  bought  for  cash  and  returned.  Sold 
N.  I.  Cluff  furniture  on  account,  $122.00.  Cash  sales  hardware,  $79.00. 

May  28 

Paid  the  Daily  News  for  advertising,  $20.00.  Cash  sales,  hardware, 
$71.00;  furniture,  $55.00. 

May  29 

Sold  Peter  Henderson  hardware  on  account,  $63.00.  H.  Rowe  re- 
turned goods  purchased  May  21,  $20.00.  Cash  sales,  hardware,  $45.00; 
furniture,  $27.  50. 


CONSTRUCTION  OF  ACCOUNTS— PROPRIETORSHIP  ACCOUNTS   287 

May  jo 

Paid  Huron  Supply  Co.'s  invoice  of  May  13,  net.  Sold  Dr.  D.  Kelly 
furniture  on  account,  $105.00.  Cash  sales,  hardware,  $57.00. 

May  31 
Cash  sales,  hardware,  $68.00;  furniture,  $50.00. 

Take  the  totals  of  all  the  columns  in  your  special  books  of  original  entry. 
Make  sure  that  the  total  of  the  debit  columns  in  each  journal  equals  the  total 
of  the  credit  footings.  (For  purposes  of  this  checking  subtract  the  begin- 
ning cash  balance  from  the  total  of  the  debits  in  the  cash  receipts  journal.) 
Rule  up  these  special  books  of  entry  and  complete  all  posting,  both  to  the 
general  ledger  and  to  the  subsidiary  ledgers.  Make  sure  that  the  balances 
of  your  two  controlling  accounts  agree  with  the  totals  of  the  balances  in  the 
subsidiary  ledgers. 

Our  thirty-day  note,  which  was  discounted  by  the  Woodlawn  Trust 
and  Savings  Co.  on  April  25,  matured  on  May  25.  It  was  not  paid  on 
that  date,  but  was  renewed  by  giving  them  our  new  note  for  $500  at  thirty 
days,  with  interest  at  6  per  cent.  Through  an  oversight,  this  transaction 
was  left  off  the  books.  Make  the  necessary  entries  as  of  May  31. 

The  merchandise  inventories  on  May  31  are  as  follows:  hardware, 
$4,560.00;  furniture,  $525.00.  Store  supplies  on  hand  (paper,  twine,  etc.) 
are  valued  at  $90.00.  Salaries  are  accrued  for  five  days.  An  allowance 
for  bad  debts  is  to  be  made  equal  to  i  per  cent  of  the  total  amount  at  present 
due  from  customers.  Depreciation  on  each  class  of  equipment  is  to  be 
taken  at  the  same  rate  as  was  indicated  last  month. 

On  the  basis  of  this  information  and  of  your  own  investigation  with 
respect  to  the  interest  prepaid  or  accrued  on  the  various  notes  receivable 
and  payable,  and  as  to  the  amount  of  insurance  expired,  prepare  the  balance 
sheet  and  the  statement  of  profit  and  loss. 

Make  in  the  journal  the  entries  necessary  to  bring  the  ledger  accounts 
into  agreement  with  the  items  shown  in  the  reports  (adjusting  entries) 
Post  these  entries. 

Make  and  post  the  entries  necessary  to  close  the  books. 

NOTE. — For  those  who  desire  further  laboratory  material,  an  additional 
month's  transactions  are  given  in  the  appendix  on  page  379. 


CHAPTER  XXV 

THE  CONSTRUCTION  AND  INTERPRETATION  OF 
ACCOUNTS— INCOME  ACCOUNTS 

Kinds  of  income  accounts.  There  are  two  classes  of  income  ac- 
counts, so  clearly  set  apart  from  each  other  that  they  appear  in  differ- 
ent parts  of  the  profit  and  loss  statement.  They  are:  (i)  accounts 
with  operating  income;  (2)  accounts  with  "other  income,"  or  non- 
operating  income  accounts.  By  "operating  income"  is  meant  the 
income  derived  from  the  operations  for  which  the  business  is  organized, 
and  to  which  the  management  may  look  for  the  chief  source  of  income. 
This  sort  of  income  arises  from  the  sale  of  the  goods  or  services  in  which 
the  particular  business  deals,  the  nature  of  such  goods  and  services 
varying  with  the  type  of  the  business  enterprise. 

The  non-operating  income  of  any  business  is  that  income  which 
accrues  to  the  business  from  sources  other  than  those  upon  which  the 
business  depends  for  its  primary  income.  An  example  of  such  non- 
operating  income  is  the  rent  received  from  a  building  or  other  real 
estate  held  by  the  business  as  an  incidental  investment.  Interest 
earned  on  notes  and  investments  held,  or  on  bank  balances,  is  non- 
operating  income  to  any  but  a  financial  business.  Almost  any  item  of 
income  may  be  either  operating  or  non-operating  income,  according 
to  the  nature  and  purpose  of  the  business  in  which  such  income  accrues. 

Accounts  with  operating  income.  It  was  pointed  out  above  that 
there  may  be  several  kinds  of  operating  income  in  connection  with  as 
many  kinds  of  business.  Thus  in  the  case  of  a  railroad,  accounts  would 
be  needed  to  show  income  from  passenger  traffic,  freight  traffic,  and 
earnings  from  express  and  mail  business.  In  connection  with  a  hotel 
the  main  operating  income  is  usually  the  rent  of  the  rooms.  But  for 
the  present  it  is  not  necessary  to  give  consideration  to  types  of  business 
other  than  the  ordinary  mercantile  and  manufacturing  businesses, 
in  which  operating  income  arises  from  the  sale  of  goods  and  may  be 
represented  by  one  or  more  sales  accounts. 

Sales  account.  Thus  in  a  manufacturing  or  mercantile  business 
there  will  always  be  a  sales  account  in  which  will  be  recorded  the 
amount  of  the  sales  made  during  each  accounting  period,  and  the 

288 


CONSTRUCTION  OF  ACCOUNTS— INCOME  ACCOUNTS        289 

balance  of  this  account  at  the  end  of  the  period  shows  the  amount  of 
operating  revenue  from  this  source  during  the  period.  From  this 
the  operating  expenses  must  be  deducted  in  order  to  ascertain  the 
net  operating  profit  or  loss. 

If  the  business  sells  different  lines  of  commodities,  or  if  it  is  organ- 
ized into  several  departments,  each  of  which  is  making  sales,  the 
sales  account  will  be  subdivided  to  show  whatever  classification  of 
sales  may  be  desirable  for  the  particular  organization.  Thus  a 
mercantile  business  with  several  departments  may  have  its  sales 
account  divided  into  "Sales — Department  A,"  "Sales — Depart- 
ment B,"  and  a  similar  account  for  every  other  selling  department. 
A  manufacturing  concern  making  and  selling  three  lines  of  product 
may  have  a  sales  account  for  each,  as  follows:  "Sales — Product 
No.  i,"  "Sales— Product  No.  2,"  " Sales— Product  No.  3."  It  is 
also  possible  that  the  departmental  or  product  sales  accounts  may  be 
further  classified.  There  might  be  a  sales  account  to  show  the  amount 
of  the  sales  of  each  of  the  three  products  in  each  of  the  territories  in 
which  the  manufacturing  concern  markets  its  goods.  This  matter  of 
the  subdivision  of  the  sales  account  is  one  of  classification,  and  any- 
thing like  an  adequate  consideration  of  the  subject  must  be  deferred 
to  a  later  point  in  the  study  of  accounting. 

The  nature  of  any  subsidiary  sales  account  is  exactly  the  same  as 
that  of  the  general  sales  account  which  shows  the  total  sales.  To 
show  the  construction  and  interpretation  of  accounts  with  sales,  then, 
it  is  not  necessary  to  consider  more  than  one  such  account.  The 
debits  and  credits  to  the  sales  account  are  as  seen  on  page  290. 

It  will  be  seen  from  the  foregoing  discussion  that  the  balance  of 
the  sales  account  before  any  of  the  closing  entries  have  been  made  and 
posted  will  be  a  credit  balance,  and  will  represent  the  amount  of  gross 
sales  for  the  period.  This  is  the  item  that  will  appear  on  the  reports. 
The  account  is  not  debited,  as  a  usual  thing,  except  through  the  closing 
entries,  though  in  some  smaller  businesses  the  sales  deductions  may 
not  be  kept  in  separate  accounts  but  entered  directly  to  the  debit  of 
sales  at  the  time  when  they  occur.  This  would  make  the  credit 
balance  of  the  sales  account  show  the  amount  of  net  sales.  This 
method  is  not  usually  a  desirable  one  in  a  larger  business,  since  in 
most  cases  there  would  be  required  a  more  detailed  analysis  of  these 
deductions  than  could  be  readily  obtained  from  the  sales  account. 


290 


PRINCIPLES  OF  ACCOUNTING 


The  sales  account,  like  other  revenue  accounts,  is  closed  into 
profit  and  loss  at  the  close  of  each  fiscal  period,  and  shows  no  balance 
at  the  beginning  of  a  new  period.  The  exact  procedure  to  be  fol- 
lowed in  the  process  of  closing  this  account  may  vary  somewhat. 
This  matter  was  discussed  in  chapter  x,  and  will  be  further  consid- 
ered in  chapter  xxviii. 

SALES 


Debit: 

Only  with  the  closing  entries  made  at 
the  end  of  the  fiscal  period,  which 
will  probably  be  as  follows: 
a)  With  any  sales  deductions  to  be 

closed  into  sales  account. 
6)  With  the  balance  of  purchases 
account,  showing  cost  of  goods 
sold   (provided  this  method  is 
followed  in  closing). 
c)  With  the  credit  balance  of  sales 
account,  to  be  transferred  to  the 
profit  and  loss  account   (sales 
might  show  a  debit  balance,  but 
such  is  not  normally  the  case). 


Credit: 

With  the  amount  of  all  invoices  of 
merchandise  or  finished  product 
sold. 


Deductions  from  sales.  As  indicated  previously,  the  figure  of 
sales  shown  in  the  reports  is  usually  that  of  gross  sales.  By  gross  sales 
is  meant  the  total  of  all  sales  invoices,  before  any  deductions  are  made 
for  returns,  allowances,  and  the  like.  This  figure  is  a  useful  one  for 
reporting  purposes,  since  it  affords  a  basis  for  comparison  between 
total  sales  and  sales  deductions.  It  does  not,  however,  show  the 
amount  of  the  actual  income  derived  from  the  sales  of  the  period  until 
these  deductions  have  been  made. 

The  deductions  most  commonly  made  from  gross  sales  are  those 
for  returns  and  allowances,  and  for  outward  freight  prepaid  by  the 
seller.  The  amount  of  goods  returned,  as  well  as  allowances  or 
rebates  made  to  customers  on  sales,  quite  plainly  represent  a  part  of 
the  total  of  gross  sales  that  will  never  become  realized  income,  and 
should  therefore  be  deducted  to  arrive  at  the  figure  of  net  sales.  And 
where  the  seller  pays  the  charges  on  an  out-of-town  shipment  of 
goods,  such  charges  are  usually  treated  as  a  deduction  from  gross  sales. 
Such  charges  are  ordinarily  borne  by  the  purchaser,  and  when  the 
shipper  pays  the  freight  he  is  either  adding  it  to  his  normal  selling 


CONSTRUCTION  OF  ACCOUNTS— INCOME  ACCOUNTS        291 


price  or  else  is  taking  this  method  of  making  a  special  price  concession 
to  the  purchaser.  In  either  case,  it  is  usually  treated  as  a  direct 
deduction  from  gross  sales,  though  in  the  latter  case  it  may  be  treated 
as  a  selling  expense,  like  delivery  expense. 

Sales  Returns  and  Allowances  may  be  taken  as  typical  of  the 
accounts  which  represent  such  items  of  sales  deductions.  It  is 
debited  and  credited  as  follows: 

SALES  RETURNS  AND  ALLOWANCES 


Debit: 

With  invoice  price  of  goods  returned 

by  customers  for  cash  refunds  or  for 

credit. 
With  all  rebates  and  allowances  made 

to  customers  for  any  reason. 


Credit: 

Only  for  the  closing  entry  which 
transfers  the  balance  of  this  account 
to  the  debit  of  sales  at  the  end  of 
the  fiscal  year. 


The  debit  balance  of  such  an  account  represents  the  amount  that  must 
be  deducted  from  the  gross  sales  for  the  period  in  order  to  obtain  the 
figure  of  net  sales  or  of  actual  income  realized  from  sales. 

Where  the  sales  account  is  subdivided  on  a  departmental  or  a 
commodity  basis,  the  accounts  with  sales  deductions  would  also  need 
to  be  subdivided  on  the  same  basis.  Thus  each  sales  account  would 
have  a  corresponding  sales  deductions  account  for  each  class  of  such 
items. 

Nan-operating  income  accounts.  It  has  been  suggested  that  there 
may  be  a  considerable  variety  of  non-operating  income  accounts, 
since  any  possible  form  of  income  accruing  in  a  given  business  which 
does  not  fall  under  the  regular  operating  income  of  that  business  is 
classified  as  non-operating  income.  Interest  earned,  rentals  earned, 
sales  of  scrap  and  waste,  income  from  incidental  investments,  and 
cash  discounts  taken  on  purchases,  may  all  fall  under  this  head. 

It  is  not  worth  while  to  discuss  every  conceivable  form  of  non- 
operating  income,  or  even  to  name  them,  but  two  items  of  frequent 
occurrence  in  the  average  business  may  be  taken  as  typical  of  the 
entire  class.  These  are:  (i)  interest  on  notes  receivable  and  (2)  cash 
discount  on  purchases. 

Interest  on  notes  receivable.  Sometimes  notes  are  received  from 
customers  and  others  which  are  made  payable  with  interest  at  a  stated 
rate.  In  such  a  case,  if  the  note  is  held  for  any  part  of  the  time  it  has 


PRINCIPLES  OF  ACCOUNTING 


to  run,  some  interest  will  accrue  to  the  business  holding  it.  Such 
accrual  represents  an  earning  of  that  business  for  the  period  during 
which  it  occurs,  but  an  earning  of  a  purely  financial  nature,  which  is 
outside  the  primary  income-earning  operations  of  the  business,  like 
interest  earned  on  outside  investments.  It  is  therefore  classed  as 
non-opera  ting,  or  "other"  income.  The  debits  and  credits  to  be 
made  to  the  account  with  interest  on  notes  receivable  may  be  Indicated 
as  follows: 

INTEREST  ON  NOTES  RECEIVABLE 


Debit: 

When  the  books  are  closed  at  the  end 
of  a  fiscal  period,  with  the  amount 
of  the  credit  balance  transferred  to 
profit  and  loss  account. 


Credit: 
With    the    amounts    of   all    interest 

payments  received  on  such  notes. 
At  the  end  of  each  fiscal  period  with 

the   amount   of   all   such   interest 

accrued  but  not  yet  due. 


The  balance  of  this  account  is  normally  on  the  credit  side,  and  should 
represent  the  amount  of  such  interest  earned  by  the  business  during 
the  current  period.  The  method  by  which  this  account  is  to  be 
adjusted  and  closed  will  be  explained  in  a  later  chapter. 

Cash  discount  on  purchases.  The  student  is  already  familiar  with 
the  nature  of  cash  discount  on  purchases.  This  is  a  certain  percent- 
age, frequently  2  per  cent,  but  sometimes  more  or  less,  which  the 
purchaser  is  allowed  to  deduct  from  the  face  of  the  invoice  if  he 
pays  it  within  a  time  limit  set.  Some  accountants  argue  that,  since 
this  represents  a  reduction  of  the  price  actually  paid  for  the  goods,  it 
should  be  treated  not  as  other  income  but  as  a  deduction  from  pur- 
chases. The  weight  of  opinion  among  writers  on  the  subject  is, 
however,  that  this  item  should  be  included  under  other  income. 
The  reason  assigned  for  this  is  that  it  is  not  really  a  reduction  in  the 
purchase  price,  which  is  the  same  whether  the  purchaser  exercises 
his  option  of  taking  the  discount  or  not.  It  represents  rather  a 
saving  due  to  proper  financial  management,  and  to  the  ability  to 
secure  credit  at  the  bank  when  this  is  needed  to  be  able  to  take 
discounts.  Also,  since  the  interest  incurred  on  funds  borrowed  from 
the  bank  for  the  purpose  of  enabling  the  concern  to  take  its  discounts 
is  treated  as  a  deduction  from  total  income,  as  will  be  explained  later, 
it  would  be  rather  misleading  to  show  the  total  of  cash  discounts  as  a 
deduction  from  the  purchase  price  of  the  goods.  It  is  really  income 


CONSTRUCTION  OF  ACCOUNTS— INCOME  ACCOUNTS   293 


arising  out  of  the  financial  operations  of  the  business,  like  interest 
earned  on  notes  and  investments. 

The  debits  and  credits  to  be  made  to  this  account  may  be  indicated 

as  follows: 

CASH  DISCOUNT  ON  PURCHASE 


Debit: 

When  the  account  is  closed  at  the  end 
of  the  fiscal  period,  with  the  amount 
of  the  credit  balance  transferred  to 
profit  and  loss. 


Credit: 

\Yith  all  discounts  taken  for  payment 
of  purchase  invoices  within  the  time 
limit  set. 


The  credit  balance  shown  by  this  account  at  the  end  of  a  period  rep- 
resents the  amount  of  cash  discounts  taken  on  purchases  during  the 
fiscal  period.  It  appears  as  an  item  on  the  statement  of  profit  and 
loss  under  the  head  of  "  Other  Income." 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  What  purpose,  if  any,  is  served  by  dividing  income  accounts  into  two 
main  groups,  operating  and  non-operating?    Define  the  basis  of  dis- 
tinction. 

2.  Should  you  prefer  the  terms  "primary"  and  "secondary"  to  "oper- 
ating" and  "non-operating"  as  applied  to  the  classification  of  income? 
What  reasons  have  you  for  your  answer  ? 

3.  The  X  Music  Company  sells  pianos,  phonographs  and  records,  band 
instruments,  and  sheet  music.    The  company  has  its  main  office  in 
Chicago,  where  its  principal  selling  establishment  is  located.    It  has 
branches  in  St.  Louis,  Kansas  City,  and  Omaha.    Each  of  its  stores 
sells  both  to  dealers  and  direct  to  consumers.    What  basis  or  bases 
should  you  suggest  for  the  classification  of  this  company's  sales  account  ? 
What  purposes  would  be  served  by  the  classification  suggested  by  you  ? 

4.  Should  you  advise  that  the  X  Company  carry  separate  accounts  to 
show  sales  deductions  ?    Why,  or  why  not  ?    If  you  advise  keeping  such 
accounts,  how  should  they  be  classified? 

5.  What  possible  sources  can  you  suggest  from  which  the  X  Company 
might  derive  non-operating  income?    Explain  clearly  in  each  case 
why  you  classify  the  particular  type  of  income  as  non-operating. 
What  accounts  would  be  required  to  record  such  income  ? 

6.  Which  do  you  consider  the  correct  view:    That  cash  discounts  taken 
on  purchases  are  a  source  of  income,  or  that  all  such  discounts  which 
are  not  taken  represent  a  loss  ?    Will  either  of  these  views  differ  from 
the  other  with  respect  to  the  accounts  needed  to  carry  it  out  ?   Explain. 


294  PRINCIPLES  OF  ACCOUNTING 

7.  Can  you  justify  the  current  accounting  practice  of  showing  income 
resulting  from  the  financial  management  of  the  business  as  non-operating 
income  ?    Discuss. 

8.  Give  the  journalization  of  the  following  transactions,  and  justify  your 
analysis  in  each  case:    (a)  the  prepayment  of  freight  on  a  shipment 
outward,  the  amount  of  such  charge  being  added  to  the  amount  of  the 
invoice;   (b)  the  prepayment  of  freight  outward  when  the  price  was 
quoted  f.o.b.  the  customer's  station. 

9.  The  practice  of  giving  discounts  for  prompt  payment  of  invoices  is  one 
which  arose  shortly  after  the  Civil  War.     What  is  the  justification  for 
the  practice  ?    How  do  you  account  for  its  survival  ? 

REFERENCES  FOR  FURTHER  STUDY 

WILDMAN,  J.  R.,  Principles  of  Accounting,  chaps,  xxxiii  and  xxxviii. 

HATFIELD,  H.  R.,  Modern  Accounting,  chaps,  xi  and  xii. 

KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vok  II,  chap.  xxii. 


CHAPTER  XXVI 

THE  CONSTRUCTION  AND  INTERPRETATION  OF 
ACCOUNTS— EXPENSE  ACCOUNTS 

Kinds  of  expense  accounts.  Like  income  accounts,  expense 
accounts  may  be  divided  into  two  main  groups:  operating  and  non- 
operating.  The  operating  expenses  may  be  classified  in  any  way  that 
seems  desirable  in  the  particular  business  organization,  but  in  any 
case  they  may  be  divided  into  two  groups.  The  first  of  these  consists 
of  those  items  which  show  the  cost  of  the  goods  sold,  and  the  second 
consists  of  the  remainder  of  the  operating  expenses  necessary  to  carry 
on  the  business,  provide  for  the  purchase  and  sale  of  goods,  for  their 
delivery,  and  for  all  other  necessary  phases  of  the  primary  operations 
of  the  business.  This  classification  of  expense  accounts  may  be 
indicated  as  follows:  % 

I.  Operating  expense  accounts 
.  i.  Accounts  with  cost  of  goods  sold 
a)  Purchases  account 
6)  Other  cost  of  goods  sold  accounts 
2.  Other  operating  expense  accounts  (classified  according  to 

the  reporting  requirements  of  the  individual  business) 
II.  Non-operating  expense  accounts,  or  "other  deductions  from 

income"  accounts 

The  classes  of  accounts  shown  by  this  outline  will  be  considered  in  the 
order  in  which  they  there  appear. 

Operating  expense  accounts.  It  was  .pointed  out  in  the  preceding 
chapter  that  there  may  be  a  considerable  variation  in  the  operating 
income  accounts  of  different  businesses.  The  operating  expenses 
may  vary  even  more  widely,  as  regards  the  individual  items  with 
which  such  accounts  will  be  kept.  But  for  all  that,  it  is  not  par- 
ticularly difficult  to  distinguish  between  operating  expenses  and 
non-operating  expenses  in  any  given  business,  once  the  nature  and 
purpose  of  the  business  is  clearly  understood.  The  operating  expenses 
in  general  are  those  expenses  that  are  incurred  necessarily  and  directly 

295 


296  PRINCIPLES  OF  ACCOUNTING 

in  carrying  on  those  operations  which  lead  to  the  earning  of  the 
primary  or  operating  income  of  the  business. 

Cost-of-goods-sold  accounts.  The  primary  income  of  any  business 
comes  through  the  sale  of  something,  whether  a  commodity  or  a 
service.  It  follows  that  a  prime  essential  for  the  securing  of  this 
income  is  to  have  something  to  sell.  In  this  connection,  businesses 
selling  services  will  for  the  present  be  omitted  from  the  discussion 
and  consideration  given  only  to  those  selling  commodities- of  one 
kind  or  another.  A  business  selling  goods  of  any  kind  must  secure 
the  goods  either  by  purchasing  them  or  by  producing  them.  In 
either  case,  certain  accounts  will  be  needed  to  show  the  cost  of  the 
goods  sold.  It  does  not  seem  desirable  at  this  point  to  enter  into  a 
discussion  of  the  accounts  necessary  for  this  purpose  in  a  manu- 
facturing business,  since  a  satisfactory  explanation  of  the  purpose  and 
use  of  these  accounts  would  require  more  space  than  can  well  be 
devoted  to  it  in  this  text.  The  present  discussion  of  accounts  with 
the  cost  of  goods  sold  will  therefore  be  confined  to  those  used  in 
mercantile  businesses. 

Purchases  accounts.  .The  most  important  account  in  use  for  this 
purpose  hi  a  mercantile  business  is  the  one  with  purchases.  By  this  is 
meant  the  purchases  of  merchandise  for  resale.  This  account  is 
used  to  show  the  amount  of  the  merchandise  purchased  by  the  business 
during  the  current  fiscal  period,  at  the  invoice  price.  The  reader 
is  already  quite  familiar  with  the  nature  of  the  transactions  affecting 
this  account,  and  with  the  routine  of  handling  such  transactions  and 
entering  them  on  the  books  of  original  entry.  He  is  also  aware  of  the 
fact  that  to  be  of  the  greatest  use  for  reporting  purposes,  the  pur- 
chases account  should  show  only  one  thing,  namely,  the  total  pur- 
chases for  the  period  at  the  invoiced  price.  This  means  that  the 
entries  which  will  be  made  to  this  account  during  the  accounting 
period  are  as  follows: 

PURCHASES 


Debit: 
With  the  invoiced  price  of  all  mer- 
chandise purchased. 

Credit: 

In  closing  the  accounts  at  the  end  of  the  fiscal  period,  however, 
various  methods  of  procedure  may  be  followed.    A  desirable  method 


CONSTRUCTION  OF  ACCOUNTS— EXPENSE  ACCOUNTS       297 


that  has  been  explained  in  this  text  is  to  close  all  the  accounts  affecting 
the  cost  of  goods  sold  into  purchases  account,  so  that  the  debit 
balance  remaining  to  be  transferred  from  purchases  when  that  account 
is  finally  closed  represents  the  cost  of  goods  sold.  According  to  that 
method,  also,  that  balance  is  transferred  to  the  sales  account.  Taking 
into  consideration  the  closing  entries,  made  according  to  the  method 
indicated,  the  debits  and  credits  to  the  purchases  account  are  as 
follows: 

PURCHASES 


Debit: 

With  the  invoiced  price  of  all  mer- 
chandise purchased  during  the 
period. 

By  an  adjusting  entry  at  the  close  of 
the  period,  with  the  amount  of  the 
merchandise  inventory  at  the  begin- 
ning of  the  period. 

By  the  closing  entries,  with  the  debit 
balances  of  any  other  accounts 
with  cost  of  goods  sold,  transferred 
to  purchases  account. 


Credit: 

By  an  adjusting  entry  at  the  close  of 
the  period,  with  the  amount  of  the 
merchandise  inventory  at  the  close 
of  the  period. 

By  the  closing  entries,  with  the  credit 
balances  of  any  accounts  with  pur- 
chases deductions,  transferred  to 
purchases  account. 

By  a  closing  entry,  with  the  debit 
balance  of  purchases  account,  trans- 
ferred to  sales,  or  to  some  other  ac- 
count used  in  summarizing  the 
revenue  accounts. 


From  the  foregoing  discussion,  it  appears  that  the  balance  of  the 
purchases  account  as  it  appears  on  the  trial  balance  taken  at  the  end 
of  the  accounting  period  and  on  the  accounting  reports  is  a  debit 
balance,  and  shows  the  total  gross  purchases.  In  closing  the  books, 
it  may  be  used  as  a  summary  account  and  made  to  show  the  cost  of 
goods  sold,  if  so  desired.  There  will  be  no  balance  at  all  in  the 
purchases  account  at  the  beginning  of  a  new  period. 

If  the  mercantile  business  in  question  is  organized  by  departments, 
and  the  sales  accounts  subdivided  by  departments,  in  order  to  make 
possible  the  reporting  of  operating  income  by  departments,  the  pur- 
chases account  will  need  to  be  subdivided  on  the  same  basis,  so  that 
gross  profits  may  be  shown  by  departments.  But  whatever  classi- 
fication is  made  of  purchases,  the  nature  of  each  purchases  account  is 
the  same  as  that  of  the  general  purchases  account,  and  involves  the 
same  debits  and  credits. 

Accounts  with  purchases  deductions.  As  in  the  case  of  sales,  so  in 
ascertaining  the  net  amount  of  the  cost  of  goods  purchased  during  a 
period,  there  are  certain  deductions  to  be  made.  In  some  smaller 


298 


PRINCIPLES  OF  ACCOUNTING 


businesses  these  items  are  credited  directly  to  the  purchases  account, 
but  where  such  deductions  amount  to  any  considerable  figure,  it  is 
considered  worth  while  to  have  them  shown  as  separate  items  on  the 
statement  of  profit  and  loss.  Usually  only  one  such  account  is  kept 
in  connection  with  purchases,  and  that  is  the  account  with  purchase 
returns  and  allowances.  The  debits  and  credits  to  this  account  are 
as  follows: 

PURCHASE  RETURNS  AND  ALLOWANCES 


Debit: 

For  the  closing  entry,  with  the  credit 
balance  of  this  account  transferred 
to  the  purchases  account. 


Credit: 

\Yith  the  invoiced  price  of  all  goods 

returned    to    creditors    with    their 

permission. 
With  credit  allowed  the  business  by 

creditors  for  freight  paid  on  goods 

returned. 
With  all  allowances  or  rebates  allowed 

the  business  by  creditors  for  any 

reason  whatever. 


-  The  balance  of  this  account  at  the  end  of  an  accounting  period 
is  a  credit  balance,  and  shows  the  total  credit  received  by  the  business 
for  goods  returned,  and  for  rebates  and  allowances  of  all  sorts,  this 
total  representing  a  deduction  to  be  made  from  the  amount  of  gross 
purchases  in  order  to  ascertain  the  net  cost  of  goods  purchased  during 
the  period.  If  any  subdivision  is  made  of  accounts  with  purchases, 
it  will  be  necessary  to  have  a  subdivision  of  the  purchases  returns  and 
allowances  account  on  the  same  basis,  in  order  to  show  in  the  reports 
the  amount  of  the  net  purchases  for  each  class  into  which  purchases 
are  divided. 

Other  cost-of-goods-sold  accounts.  There  are  certain  items  to  be 
included  in  the  cost  of  goods  sold,  in  addition  to  the  purchase  price 
of  the  goods.  Thus  the  total  "laid-down"  cost  of  the  goods  sold 
includes  not  only  the  purchase  price  of  such  goods  but  also  all  freight, 
express,  parcels  post,  #nd  cartage  charges  incurred  in  getting  them 
to  the  place  where  they  are  to  be  sold,  as  well  as  any  duties  or  other 
charges  that  may  have  been  incurred.  A  large  importing  concern 
might  find  it  desirable  to  maintain  several  accounts  to  show  the 
charges  of  this  nature  in  more  or  less  detail.  Ordinarily,  however,  not 
more  than  one  or  two  such  accounts  will  be  maintained.  Often  there 
is  only  one  such  account,  termed  variously  "In-Freight,"  "Freight 


CONSTRUCTION  OF  ACCOUNTS— EXPENSE  ACCOUNTS       299 


and  Cartage  Inward,"  and  "Freight,  Express,  and  Cartage  Inward." 
The  nature  of  all  the  accounts  representing  additional  charges  to 
cost  of  goods  sold  should  by  this  time  be  fairly  clear.  The  account 
with  freight,  express,  and  cartage  inward  may  be  considered  typical 
of  all  such  accounts,  and  the  nature  of  the  debits  and  credits  to  this 
account  is  shown  by  the  following: 

FREIGHT,  EXPRESS,  AND  CARTAGE  INWARD 


Debit: 

With  all  expenses  incurred  for  freight, 
express,  or  hauling  on  merchandise 
purchased. 


Credit: 

By  a  closing  entry  at  the  end  of  the 
fiscal  period,  to  transfer  the  debit 
balance  of  this  account  to  pur- 
chases. 


The  balance  of  this  account  which  will  appear  on  the  reports  is  a 
debit  balance,  and  will  be  added  to  the  amount  of  purchases  for  the 
period  in  that  part  of  the  profit  and  loss  statement  which  shows  the 
cost  of  goods  sold.  Since  this  represents  an  addition  to  the  purchases 
account,  it  should  be  subdivided  or  classified  on  the  same  basis  as 
the  purchases  account  for  purposes  of  reporting.  Thus  if  a  business 
has  four  departments,  and  a  separate  sales  account  and  purchases 
account  is  maintained  for  each  department,  a  separate  account  with 
freight,  express,  and  cartage  inward  should  also  be  maintained  for 
each  department,  so  that  cost  of  goods  sold  and  gross  profit  on  sales 
may  be  reported  by  departments. 

Other  operating  expense  accounts.  In  addition  to  the  accounts 
which  show  the  cost  of  the  goods  sold,  there  are  a  number  of  accounts 
showing  the  amount  of  various  other  operating  expenses  incurred  in 
conducting  the  business.  The  number  of  such  operating  accounts, 
and  the  classification  that  will  be  made  of  them,  will  be  determined 
by  the  reporting  requirements  of  the  business,  which  will  in  turn  be 
determined  by  the  size  of  the  business,  the  nature  of  its  operations, 
and  the  manner  in  which  it  is  organized.  Thus  the  accounts  of  a 
particular  business  may  be  such  as  to  show  the  expense  of  each  kind 
of  service  rendered,  such  as  buying,  selling,  delivering,  collecting 
the  accounts  due,  etc.,  and  to  show  the  cost  of  each  of  these  services 
for  each  department  of  the  business.  A  discussion  of  the  classifi- 
cation of  accounts  is  reserved  for  chapter  xxix.  But  in  a  business  of 
any  considerable  size  there  will  be  a  number  of  such  accounts  kept, 


300 


PRINCIPLES  OF  ACCOUNTING 


classified  in  such  a  manner  as  seems  most  useful  for  the  reporting 
requirements  of  that  particular  business. 

The  nature  and  construction  of  these  operating  expense  accounts 
differ  only  with  the  nature  of  the  expense  and  the  manner  in  which 
it  is  incurred  and  brought  into  the  books.  For  the  most  part,  the 
debits  and  credits  to  the  operating  expense  accounts  are  all  made  in 
the  same  manner.  Wages  of  Sales  Clerks  may  be  taken  as  a  type  of 
the  ordinary  operating  expense  account.  The  debits  and  credits  to 
be  made  to  this  account  would  be  as  follows: 

WAGES  OF  SALES  CLERKS 


Debit: 
With  the  amount  of  all  wages  paid  to 

sales  clerks  during  the  fiscal  period. 
At  the  end  of  the  period  withany  wages 

of  sales  clerks  which  have  accrued 

but  are  not  yet  payable. 


Credit: 

By  a  closing  entry,  with  the  debit 
balance  of  the  account,  representing 
the  amount  of  this  class  of  expense 
for  the  period,  which  is  transferred 
to  profit  and  loss. 

By  a  "post-closing"  entry,  to  transfer 
back  to  this  account  the  amount  of 
wages  accrued  but  not  yet  payable 
at  the  end  of  the  period  (for  expla- 
nation, see  chapter  xxvii). 


The  debit  balance  of  this  account  at  the  end  of  the  period  represents 
the  amount  of  such  expense  which  is  chargeable  against  the  operating 
income  of  the  period.  Where  a  post-closing  entry  causes  this  account 
to  show  a  credit  balance  at  the  beginning  of  the  new  period,  this 
balance  represents  the  amount  of  such  expense  which  was  charged 
against  the  operations  of  the  period  just  ended,  but  which  has  not 
been  paid.  This  credit  balance  will  be  wiped  out  by  the  debit  to 
this  account  resulting  from  the  first  payment  of  such  wages.  The 
resulting  debit  balance  will  be  the  part  of  that  payment  which  is 
chargeable  to  the  operations  of  the  new  period. 

In  a  business  having  several  selling  departments,  this  account  may 
be  subdivided  to  show  the  amount  of  such  expenses  chargeable  to  each 
of  these  departments. 

,,  Accounts  with  estimated  operating  expenses.  Another  type  of 
operating  expense  which  deserves  some  attention  here  is  that  kind  of 
expense  which  is  not  reckoned  by  the  amount  actually  paid  out  or 
definitely  accrued,  but  by  the  amount  which  is  estimated  according 
to  some  predetermined  scheme,  to  be  properly  chargeable  as  an 


CONSTRUCTION  OF  ACCOUNTS— EXPENSE  ACCOUNTS       301 


expense  of  the  current  period.  Examples  of  this  type  of  expense  are: 
(i)  loss  from  bad  debts,  and  (2)  depreciation  on  store  equipment. 
In  the  case  of  each  of  these  expenses,  the  amount  is  determined  by 
an  estimate,  made  at  the  end  of  the  period,  and  an  entry  is  then  made, 
debiting  the  expense  account  and  crediting  a  valuation  reserve 
account.  The  account  with  depreciation  on  store  equipment  may  be 
taken  as  typical  of  such  accounts.  The  amount  with  which  this 
account  will  be  debited  at  the  end  of  a  fiscal  period  is  determined  by 
the  original  cost  of  the  equipment  then  in  use,  and  its  estimated 
length  of  useful  life.  The  debits  and  credits  to  this  account  are  as 
follows: 

DEPRECIATION  OF  STORE  EQUIPMENT 


Debit: 

At  the  end  of  the  fiscal  period  with 
the  amount  of  that  portion  of  the 
value  of  store  equipment  to  be 
charged  to  expense  for  the  current 
period  as  determined  by  the  depre- 
ciation schedule. 


Credit: 

By  a  closing  entry,  with  the  debit 
balance  of  the  account,  to  be  trans- 
ferred to  profit  and  loss. 


The  debit  balance  of  this  account,  which  appears  on  the  statement  of 
profit  and  loss  for  the  period,  represents  the  amount  that  is  estimated 
as  chargeable  against  the  period's  operations  for  the  loss  in  value 
resulting  from  the  use  of  the  store  equipment. 

Accounts  with  other  deductions  from  income.  Just  as  there  are 
certain  items  of  income  accruing  to  a  business  which  cannot  be 
classed  as  a  part  of  the  operating  income  of  that  business,  so  there  are 
certain  items  of  expense  incurred  in  the  ordinary  business  which  cannot 
be  properly  classified  as  operating  expense.  That  is  to  say,  it  cannot 
be  definitely  connected  with  any  of  the  primary  operating  functions 
of  the  business,  and  must  therefore  be  omitted  from  consideration 
on  the  statement  of  profit  and  loss  until  after  the  net  operating  in- 
come has  been  ascertained  by  a  comparison  of  total  operating  income 
and  total  operating  expense.  Just  what  such  items  will  be  in  a 
particular  business  will  depend  largely  on  the  nature  of  the  operations 
of  that  business.  Two  such  items  that  occur  in  most  mercantile 
concerns  are:  (i)  interest  on  notes  payable,  and  (2)  cash  discount  on 
sales. 


302 


PRINCIPLES  OF  ACCOUNTING 


Interest  on  notes  payable.  It  is  quite  usual  for  the  average  business 
to  give  its  notes  to  the  bank  in  order  to  secure  credit  there  which  will 
serve  as  a  means  of  discharging  the  obligations  which  the  business  has 
incurred  to  its  creditors.  In  many  cases,  also,  notes  are  issued  to  trade 
creditors.  Notes  to  trade  creditors  sometimes  bear  interest  and 
sometimes  do  not.*  Notes  given  to  the  bank  may  bear  interest  also. 
If  not,  the  bank  deducts  the  interest  from  the  face  of  the  note  and 
credits  the  borrowing  concern  with  the  difference.  Interest  on  notes 
payable,  therefore,  is  an  item  cf  frequent  occurrence  in  the  ordinary 
business.  This  item  represents  an  expense  incurred  in  financing  the 
business,  and  should  be  kept  entirely  separate  from  the  expenses 
incurred  in  carrying  on  the  operations  for  which  the  business  is 
organized.  It  is  therefore  to  be  classed  as  ''other  deductions  from 
income."  The  debits  and  credits  to  this  account  are  as  follows: 
INTEREST  ON  NOTES  PAYABLE 


Debit: 

With  the  amount  of  all  interest  pay- 
ments made  on  such  notes. 

With  the  amount  of  discount  deducted 
from  the  face  of  notes  payable  by 
the  bank. 

At  the  end  of  each  fiscal  period  with 
the  amount  of  all  such  interest 
accrued  but  not  yet  payable. 


Credit: 

By  a  closing  entry,  with  the  amount 
of  the  debit  balance  of  this  account 
transferred  to  profit  and  loss  ac- 
count. 

By  a  post-closing  entry  with  the 
amount  of  interest  accrued  for  the 
current  period,  but  not  yet  payable 
(for  explanation,  see  chapter  xxvii). 


The  debit  balance  of  this  account  which  appears  on  the  statement 
of  profit  and  loss  represents  the  total  amount  of  such  interest  accruing 
during  the  current  period.  The  credit  balance  which  may  appear 
in  the  account  as  the  result  of  a  post-closing  entry  shows  the  amount 
of  such  interest  accrued  and  charged  against  the  income  of  the  period 
just  past,  but  not  yet  payable.  This  matter  will  be  explained  at 
length  in  the  following  chapter. 

Cash  discount  on  sales.  Cash  discount  on  sales  is  a  discount 
allowed  to  customers  for  the  payment  within  a  certain  limited  time  of 
invoices  sold  them.  It  is  sometimes  argued  that  this  item  should  be 
treated  as  a  direct  deduction  from  sales,  like  sales  returns  and  allow- 
ances, since  it  represents  a  reduction  of  the  price  of  goods.  The 
weight  of  opinion  among  accountants,  however,  seems  to  be  hi  favor  of 
treating  it. as  other  deductions  from  income.  The  reason  for  this  is 
that  this  item  represents  a  cost  of  a  financial  nature.  The  price  of  the 


CONSTRUCTION  OF  ACCOUNTS— EXPENSE  ACCOUNTS       303 


goods  is  the  same,  whether  the  customer  exercises  his  option  with  re- 
gard to  the  discount  or  not.  The  discount  allowed  is  partly  in  the 
nature  of  insurance  against  bad  debts,  and  partly  in  the  nature  of 
interest  paid  for  the  use  of  the  money  between  the  discount  date 
and  the  time  when  the  payment  would  otherwise  be  due.  For  this 
reason,  this  item  is  to  be  considered  rather  as  a  financial  expense 
than  as  a  deduction  from  sales.  It  is  therefore  usually  classified  as 
non-operating. 

The  debits  and  credits  to  the  account  with  cash  discount  on  sales 
are  as  follows: 

CASH  DISCOUNT  ON  SALES 


Debit: 

With  all  discounts  taken  by  customers 
for  the  payment  of  sales  invoices 
within  the  time  allowed. 


Credit: 

By  a  closing  entry,  with  the  amount 
of  the  debit  balance  of  the  account 
transferred  to  profit  and  loss 
account. 


The  debit  balance  shown  by  this  account  at  the  end  of  a  fiscal  period 
represents  the  amount  of  cash  discounts  taken  by  customers  during 
the  current  period.  This  balance  appears  on  the  statement  of  profit 
and  loss  under  the  head  of  "other  deductions  from  income." 


QUESTIONS  FOR  CLASS  DISCUSSION 

1.  How  do  you  justify  the  discussion  of  purchases  account  under  the  head 
of  operating  expenses  ? 

2.  Does  the  balance  in  purchases  account  at  the  end  of  a  period,  and  before 
any  adjustments  have  been  made,  represent  an  expense  ?    If  not, 
what  does  it  represent  ? 

3.  What  basis  of  analysis  should  you  suggest  for  the  purchase  accounts  of 
the  X  Music  Company  (see  question  3  at  the  end  of  chapter  xxv)  ? 
Give  a  complete  classification  of  the  accounts  which  should  be  used  in 
this  business  to  show  the  cost  of  sales.    Justify  your  classification. 

4.  Besides  its  four  selling  departments,  divided  according  to  commodities, 
the  X  Music  Company  maintains  a  delivery  service,  a  credit  and 
collection  department,  and  a  service  department  for  the  purpose  of 
giving  service  to  customers  on  goods  covered  by  guarantees.    The 
company  also  has  a  central  advertising  department,  which  handles  the 
advertising  for  all  its  branches,  and  gives  advertising  aid  to  dealers. 
What  does  this  suggest  to  you  with  regard  to  the  classification  of  oper- 
ating expense  which  should  be  maintained  by  this  company  ? 


304  PRINCIPLES  OF  ACCOUNTING 

5.  In  your  classification  of  expense  accounts  for  the  X  Company,  what 
disposal  should  you  make  of  depreciation  on  buildings  ?    loss  from  bad 
debts  ? 

6.  List  all  of  the  non-operating-expenses  that  you  can  think  of  which  might 
occur  in  the  X  Company's  business.    Explain  why  each  of  these  ex- 
penses is  considered  non-operating  in  its  nature. 

7.  Does  the  current  practice  of  including  cash  discount  on  sales  under 
non-operating  expenses  seem  to  you  to  be  based  on  logical  reasons  ? 
Discuss. 

REFERENCES  FOR  FURTHER  STUDY 
WILDMAN,  J.  R.,  Principles  of  Accounting,  chaps,  xxxiv,  xxxvi-xliv. 
GREENDLINGER,  LEO,  Financial  and  Business  Statements,  chap.  iv. 
DICKINSON,  A.  L.,  Accounting  Practice  and  Procedure,  chap.  iii. 


CHAPTER  XXVII 

ACCRUALS  AND  DEFERRED  ITEMS 

Special  entries  necessary  at  close  of  period.  At  the  end  of  any  fiscal 
period,  there  are  always  many  facts  concerning  the  financial  status 
of  the  business  which  have  not  yet  been  recorded  in  the  ledger  ac- 
counts, but  which  must,  nevertheless,  be  considered  if  the  financial 
reports  are  to  be  complete  and  correct  hi  their  showing.  Thus  there 
may  be  certain  items  which  really  exist  as  assets  of  the  business,  but 
which  have  not  been  entered  on  the  books,  since  no  clearly  defined 
transaction  has  arisen  to  cause  such  entry  to  be  made.  In  the  same  way 
liabilities  may  have  arisen  which  have  not  yet  any  sort  of  voucher, 
and  which  have  therefore  not  been  recorded  as  liabilities.  Income 
may  have  been  earned  or  expense  incurred  without  giving  rise  to  an 
entry ;  or  there  may  be  items  standing  on  the  books  as  expense  which 
are  not  properly  chargeable  against  the  earnings  of  the  current  fiscal 
period.  Sometimes,  also,  credits  are  entered  on  the  books  for  income 
which  are  not  properly  to  be  considered  as  an  earning  of  the  current 
fiscal  period. 

A  correct  statement  of  the  proprietorship  and  of  net  income 
for  the  period  requires  that  such  facts,  so  far  as  they  can  be  ascer- 
tained, be  recognized  and  recorded.  The  items  of  this  kind  which  will 
be  considered  in  the  present  chapter  may  be  classified  as  follows: 
(i)  accrued  income;  (2)  accrued  expense;  (3)  deferred  charges  to 
expense;  (4)  deferred  credits  to  income. 

Accrued  income.  In  order  to  state,  correctly  the  income  of  a 
given  fiscal  period,  all  the  income  which  has  been  earned  by  the 
business  during  the  period  must  be  included  in  the  statement.  In- 
come may  be  earned  during  one  period  which  does  not  become  due 
and  payable  until  some  time  which  falls  in  a  later  fiscal  period.  Such 
items  are  not  ordinarily  entered  on  the  books  before  they  become 
payable,  since  no  voucher  arises  as  the  basis  of  such  entry,  and  since 
up  to  that  time  the  amount  is  as  a  rule  continually  changing.  At  the 
end  of  an  accounting  period,  however,  they  must  be  recognized  and 

3°S 


3o6 


PRINCIPLES  OF  ACCOUNTING 


correctly  recorded  if  the  income  is  to  be  properly  apportioned  between 
periods. 

An  illustration  of  such  income  is  to  be  found  in  the  case  of  interest 
on  notes  receivable.  Thus  if  the  business  accepts  a  customer's 
sixty-day  note  for  $1,000  with  interest  at  6  per  cent,  dated  December 
i,  and  continues  to  hold  this  note  until  December  31,  the  day  of 
closing  the  books,  it  is  apparent  that  one  month's  interest,  or  $5,  has 
been  earned  during  the  period  just  ended.  On  December  31,  then, 
the  claim  of  the  business  for  this  amount  should  be  shown  on  the 
balance  sheet  as  an  asset,  and  the  amount  of  the  earning  should  appear 
on  the  statement  of  profit  and  loss  for  the  current  period. 

If  this  item  of  accrued  interest  is  to  appear  hi  the  financial  reports, 
it  should  also  appear  in  the  accounts,  since  the  balance  sheet  and 
statement  of  profit  and  loss  are  supposed  to  reflect  the  financial  facts 
about  the  business  as  shown  by  the  accounts.  To  bring  this  item 
into  the  accounts  there  must  be  a  debit  made  to  some  asset  account, 
which  may  be  called  "Accrued  Interest  Receivable,"  and  a  credit  to 
the  income  account,  "Interest  on  Notes  Receivable."  Assume  that 
this  income  account  has  been  credited  throughout  the  year  for  various 
items,  amounting  altogether  to  $31,  and  that  there  is  no  other 
item  of  accrued  interest  receivable.  Under  these  circumstances  the 
two  accounts  affected  by  the  entry  might  appear  as  follows: 

INTEREST  ACCRUED  RECEIVABLE 


1919 

Dec.  31 

e 

oo 

INTEREST  ON  NOTES  RECEIVABLE 


1919 

Feb.  iS 

. 

4 

40 

May  25 

. 

10 

80 

July  7 

. 

6 

75 

Sept.  20 

. 

3 

25 

Nov.  18 

5 

80 

Dec.  31 

Accrued 

5 

00 

When  the  closing  entries,  as  of  December  31,  are  made,  the  income 
account  will  be  closed  to  profit  and  loss,  and  will  appear,  after  posting, 
as  follows: 


ACCRUALS  AND  DEFERRED  ITEMS 
INTEREST  ON  NOTES  RECEIVABLE 


307 


1919 

1919 

Dec.  31 

To  Profit  and  Loss 

36 

00 

Feb.   15 

4 

40 

May  25 

10 

80 

July     7 

6 

75 

Sept.  20 

3 

25 

Nov.  1  8 

S 

80 

Dec.  31 

5 

oo 

36 

00 

36 

oo 

On  January  30  the  not§  will  mature  and  be  paid,  with  the  $10 
interest.  The  amount  of  interest  received  will  be  credited  to  interest 
on  notes  receivable  account,  but  as  a  matter  of  fact  only  one-half  of 
that  amount  represents  an  earning  of  the  period  in  which  the  entry 
for  its  receipt  is  made.  The  other  half  of  the  interest  was  earned  and 
credited  to  income  in  the  preceding  period.  This  fact  may  be  indi- 
cated and  a  correct  showing  of  income  provided  for  in  the  ledger  by 
closing  the  accrued  income  account  into  the  income  account  after  the 
ledger  has  been  closed  at  the  end  of  a  period.  After  this  entry  has 
been  made  and  posted,  the  two  accounts  affected  will  appear  as  follows: 

INTEREST  ACCRUED  RECEIVABLE 


1919 

Dec.  31 

. 

5 

oo 

1920 
Jan.     i 

. 

5 

00 

INTEREST  ON  NOTES  RECEIVABLE 


1919 

1919 

Dec.  31 

To  Profit  and  Loss 

36 

oo 

Feb.   15 

4 

40 

May  25 

10 

So 

July     7 

6 

75 

Sept.  20 

3 

25 

Nov.  18 

5 

80 

Dec.  31 

Accrued 

5 

00 

36 

oo 

36 

00 

1920 

Jan.     i 

. 

5 

oo 

On  January  30,  when  the  $10  interest  is  received  and  credited  to 
interest  on  notes  receivable,  the  $5  debit  already  made  to  that  account 


308  PRINCIPLES  OF  ACCOUNTING 

by  transferring  the  balance  back  from  the  accrued  asset  account  will 
offset  the  credit  by  that  amount,  making  the  net  credit  only  $5,  which 
is  the  amount  actually  earned  during  1920. 

The  foregoing  discussion  of  the  treatment  of  accrued  interest 
receivable  applies  to  other  items  of  accrued  income.  If  there  are  a 
number  of  such  items  at  the  end  of  a  period,  it  is  not  always  necessary 
to  carry  a  separate  account  for  each  kind  of  income  accrued.  It  is 
usually  sufficient  to  carry  a  single  account  with  accrued  income. 
Whether  one  or  several  items  of  this  nature  are  shown  in  the  ledger 
accounts  will  of  course  depend  on  the  classification  which  is  desired 
in  the  balance  sheet.  Such  items  are  shown  on  the  balance  sheet 
among  the  current  assets. 

Accrued  expenses.  If  it  is  necessary  to  the  correctness  of  the 
financial  reports  that  all  items  of  current  income  should  be  included, 
it  is  equally  necessary  that  all  items  of  current  expense  should  be 
shown.  At  the  end  of  a  fiscal  period  there  are  almost  always  some 
services  which  have  been  received  by  the  business  but  for  which  pay- 
ment will  not  be  due  until  some  time  in  the  following  period.  In  the 
normal  course  of  business  procedure  no  entry  is  made  on  the  books 
of  either  the  expense  or  the  liability  until  the  latter  becomes  payable, 
and  some  sort  of  voucher  arises  to  serve  as  a  basis  of  such  entry.  The 
most  common  example  of  such  an  accrued  expense  item  is  to  be  found 
in  the  pay-roll.  Assuming  that  wages  are  payable  on  Saturday,  and 
that  the  fiscal  period  ends  on  Wednesday,  it  is  evident  that  the  busi- 
ness has  incurred  as  an  item  of  expense  the  cost  of  three  days'  wages, 
and  also  that  they  have  a  liability  for  this  amount.  These  "accrued 
wages"  should  appear  on  the  balance  sheet  as  a  liability,  and  also 
on  the  statement  of  profit  and  loss  as  an  expense  of  the  current  period. 

Since  such  items  of  accrued  expense  are  to  be  shown  on  the  bal- 
ance sheet  and  the  statement  of  profit  and  loss,  they  must  also  be 
shown  by  the  accounts  at  the  time  these  reports  are  made  up.  This 
necessitates  an  entry  debiting  the  appropriate  expense  account  and 
crediting  the  account  which  represents  the  accrued  liability.  The 
account  with  salaries  of  sales  force  may  be  used  for  illustration.  It 
may  be  assumed  that  on  December  31  this  account  shows  a  balance  of 
$5,630,  which  represents  the  total  charges  to  the  account  for  the  year 
1919.  The  amount  accrued  for  the  first  three  days  of  the  week  ending 
January  3,  1920,  is  $55.  After  the  entry  recording  the  accrual  has 


ACCRUALS  AND  DEFERRED  ITEMS 


309 


been  made  and  posted,  the  two  accounts  involved  will  appear  as 
follows: 

SALARIES  OF  SALES  FORCE 


1919 

Dec.  31 

Balance 

5,63° 

oo 

3i 

Accrued 

55 

oo 

1919 

Dec.  31 

Sales  force 

55 

00 

When  the  closing  entries  for  the  period  have  been  made  and 
posted,  this  expense  account  will  have  been  closed  to  profit  and  loss, 
and  will  show  the  following: 

SALARIES  OF  SALES  'FORCE 


1919 

Dec.  31 
3i 

Balance 

Accrued 

5,63° 
55 

oo 
oo 

1919 

Dec.  31 

To  Profit  and  Loss 

5,68S 

00 

5,685 

oo 

5,68s 

00 

•When  the  week's  wages  are  paid  on  January  3,  $110  will  be  paid 
to  the  sales  force.  This  will  be  debited  to  the  account  with  salaries 
of  sales  force.  *  But  if  no  other  adjustment  is  made  of  the  account 
balances,  this  account  will  be  overstated  by  $55,  since  that  portion 
of  the  week's  pay-roll  has  already  been  charged  off  against  last 
period's  earnings.  This  would  also  fail  to  show  that  the  accrued 
liability  is  now  canceled.  This  difficulty  is  avoided  by  an  entry 
made  immediately  after  closing  the  ledger  for  1919,  by  which  accrued 
wages  is  debited  for  the  amount  of  its  balance,  and  salaries  of  sales 
force  credited.  Assuming  that  such  an  entry  is  made,  and  that  an 
entry  is  made  on  January  3  to  record  the  payment  of  the  week's 
wages,  the  expense  account  and  accrued  liability  account  would  then 
appear  as  on  page  310. 

It  is  apparent  from  the  following  illustration  that  after  the  wages 
have  been  paid  on  January  3,  the  account  with  salaries  of  sales  force 
will  show  the  correct  balance,  since  the  $110  debit  is  offset  by  the  $55 
credit,  representing  the  amount  which  has  already  been  charged  to 


PRINCIPLES  OF  ACCOUNTING 


profit  and  loss  and  is  therefore  not  to  be  included  in  the  expense  of 
the  current  period. 

The  foregoing  discussion,  with  the  illustration,  applies  to  the 
treatment  of  accrued  expenses  in  general.  It  is  not  always  necessary 
to  set  up  a  separate  liability  account  for  each  kind  of  expense  which 
is  accrued.  A  single  account  with  accrued  expense  will  usually  serve 
satisfactorily,  unless  for  some  reason  further  analysis  of  such  liabilities 
is  to  be  shown  on  the  balance  sheet.  The  place  of  such  an  account  on 
the  balance  sheet  is  among  the  current  liabilities. 

SALARIES  OF  SALES  FORCE 


1919 

Dec.  31 
3i 

Balance 
Accrued 

Cash 

5»63o 
55 

00 

oo 

1919 
Dec.  31 

To  Profit  and  Loss 

5,685 

oo 

00 

5,68s 

oo 

5,68s 

1920 
Jan.     3 

no 

oo 

1920 
Jan.      i 

55 

oo 

ACCRUED  WAGES 


1920 
Jan.     i 

55 

oo 

1919 
Dec.  31 

55 

oo 

The  entries  affecting  accrued  income  and  expenses  are  part  of  the 
entire  group  of  adjusting  entries  made  at  the  end  of  a  fiscal  period. 
In  illustrating  these  two  kinds  of  adjusting  entries  the  accounts  as 
affected  by  the  entries  have  been  shown,  rather  than  the  entries  them- 
selves. The  adjusting  entries  as  a  group  will  be  considered  in  chapter 
xxviii. 

Deferred  charges  to  expense.  It  very  often  happens  that  a  business 
pays  in  advance  for  the  right  to  receive  a  certain  service,  or  purchases 
certain  kinds  of  supplies  in  sufficient  quantity  to  last  for  some  time. 
At  the  time  when  such  services  are  received  by  the  business  the 
amount  so  used  up  becomes  an  expense.  Also,  the  amount  of  any 
kind  of  supplies  used  up  in  a  given  period  is  an  expense  of  that  period. 
But  the  amount  of  such  services  or  supplies  which  are  paid  for  and  still 
unused  at  the  end  of  a  fiscal  period  is  said  to  be  a  deferred  charge  to 
expense,  or  a  prepaid  expense.  Some  examples  of  such  deferred 
charges  are:  prepaid  interest,  prepaid  insurance,  office  supplies 


ACCRUALS  AND  DEFERRED  ITEMS          311 

remaining  on  hand  at  the  end  of  a  period,  and  unused  service  or  sup- 
plies of  almost  any  sort,  such  as  coal,  wrapping  paper  and  twine, 
supplies  for  window  dressing,  and  the  like.  For  purposes  of  illus- 
tration unexpired  insurance  will  be  used  as  typical  of  services  unused, 
and  office  supplies  as  typical  of  supplies  on  hand. 

The  nature  of  the  service  of  insurance  is  well  known.  Business 
men,  in  order  to  minimize  the  risks  attendant  on  conducting  a  busi- 
ness, usually  contract  with  one  or  more  insurance  companies  for  the 
assumption  of  certain  of  these  risks  by  the  insurance  company.  Such 
a  contract  provides  that  in  return  for  a  certain  consideration,  known 
as  the  insurance  premium,  the  company  agrees  to  indemnify  the 
owner  for  the  loss  of  such  property  as  is  covered  by  the  contract,  such 
indemnity  not  to  exceed  a  sum  set  in  the  contract.  Such  contracts 
have  assumed  a  fairly  standardized  form,  and  are  known  as  insurance 
policies.  Such  a  policy  is  drawn  to  cover  a  definite  period  of  time, 
usually  a  year,  and  the  premium  is  always  payable  in  advance. 

INSURANCE  POLICY  RECORD 

(Left-hand  Page) 


Date  of 
Policy 

Number 

Name  of 
Company 

Property 
Insured 

Amount 

Expires 

Total 

Premium 

INSURANCE  POLICY  RECORD 
(Right-hand  Page) 


MONTHLY  EXPIRATIONS 


AMOUNT 

CARRIED 
FORWARD 

Jan. 

Feb. 

Mar. 

April 

May 

June 

July 

Aug. 

Sept. 

Oct. 

Xov. 

Dec. 

It  is  quite  usual  for  a  business  firm  to  have  at  one  time  several 
such  policies,  entered  into  with  different  companies,  at  different 
times,  and  covering  risks  on  different  property.  Where  this  is 
true,  it  is  desirable  to  have  some  record  of  the  different  policies. 


312 


PRINCIPLES  OF  ACCOUNTING 


Such  as  record  should  show  when  each  policy  expires,  and  also  the 
amount  of  the  premium  which  is  to  be  charged  to  expense  during  a 
given  fiscal  period,  and  the  amount  which  represents  a  deferred  charge 
at  the  end  of  such  period.  A  form  of  such  an  insurance  policy  record, 
which  furnishes  the  information  desirable  with  regard  to  the  policies 
held  by  the  business,  is  shown  on  page  311. 

Whenever  an  insurance  policy  is  taken  out  by  a  business  using 
such  a  record  as  the  above,  it  is  recorded,  entering  in  the  monthly 
columns  the  amount  of  the  premium  which  will  expire  during  the 
current  year,  and  in  the  column  headed  "Amount  Carried  Forward" 
the  amount  that  will  be  unused  at  the  end  of  the  current  fiscal  year. 
The  entry  for  the  payment  of  the  premium  is  made  in  the  cash  book, 
debiting  prepaid  insurance  account,  or  insurance  unexpired. 

The  purpose  of  the  prepaid  insurance  account  is  to  show  the 
amount  of  insurance  premiums  paid  which  have  not  yet  expired. 
It  is  debited  with  the  amount  of  all  premiums  paid,  and  credited 
at  the  end  of  each  month  with  the  total  of  the  premiums  shown  by 
the  insurance  policy  record  to  have  expired  within  that  month,  the 
corresponding  debit  being  to  the  expense  account  affected  by  such 
expiration.  The  debits  and  credits  to  the  prepaid  insurance  account 
may  be  summarized  as  follows: 

PREPAID  INSURANCE 


Debit: 

With  amounts  of  all  insurance  premi- 
ums paid. 


Credit: 

At  the  end  of  each  month  with  all 
amounts  of  insurance  premiums 
expired,  as  shown  by  the  insurance 
policy  record,  or  otherwise  deter- 
mined. 

With  insurance  premiums  refunded 
on  canceled  policies. 


The  balance  of  this  account  after  the  proper  credits  have  been  made 
to  it  shows  the  amount  of  the  unexpired  premiums  and  appears  on  the 
balance  sheet  as  a  prepaid  expense,  or  deferred  charge  to  expense. 

At  the  beginning  of  a  new  fiscal  year  the  insurance  policy  record 
will  be  ruled  up  and  a  new  entry  made  for  the  policies  still  in  force, 
carrying  down  the  amount  of  premium  unexpired  on  each,  and 
distributing  the  expirations  for  the  new  year  by  months,  as  before. 

Office  supplies  may  be  taken  as  an  example  of  supplies  on  hand  at 
the  end  of  a  fiscal  period.  This  item  includes  such  things  as  station- 


ACCRUALS  AND  DEFERRED  ITEMS 


313 


ery,  stamps,  pencils,  pens,  clips,  etc.  The  account  with  office  supplies 
is  intended  to  show  the  cost  of  all  such  supplies  purchased,  the  amount 
used  up  within  the  period,  and  the  amount  remaining  unused  at  the 
end  of  the  period.  It  will  be  debited  and  credited  as  follows: 

OFFICE  SUPPLIES 


Debit; 

With  the  cost  of  all  office  supplies 
purchased  during  the  accounting 
period. 


Credit: 

With  the  cost  of  all'  office  supplies 
used  or  in  any  way  disposed  of 
during  the  period. 


When  "Office  Supplies  "is  credited,  the  corresponding  debit  is  to 
the  expense  account  chargeable  with  the  supplies  used.  This  is 
usually  "Office  Expense"  or  "Administrative  Expense."  Except  in 
very  large  businesses,  it  is  not  usually  considered  worth  while  to  keep 
a  continuous  record  of  the  amount  of  office  supplies  on  hand  and  the 
amount  used.  Where  this  is  not  done,  the  cost  of  the  supplies  used  is 
obtained  by  taking  an  inventory  of  such  supplies  at  the  end  of  each 
period.  The  amount  of  the  inventory  represents  the  amount  of  the 
debit  balance  that  should  appear  in  the  office  supplies  account.  The 
difference  between  this  amount  and  the  balance  actually  shown  in 
that  account  is  therefore  taken  to  represent  the  amount  used  during 
the  period,  and  this  amount  is  debited  to  some  expense  account  and 
credited  to  the  office  supplies  account.  The  balance  remaining  is 
consequently  the  amount  of  the  inventory,  and  this  amount  is  shown 
on  the  balance  sheet  as  a  deferred  charge  to  expense. 

Deferred  credits  to  income.  Income  is  sometimes  received  during 
one  period  which  has  not  been  earned  by  the  business  during  that 
period  but  will  be  earned  in  the  following  fiscal  period.  Such  items 
of  income  are  known  as  deferred  credits  to  income.  Examples  of  such 
deferred  credits  are  to  be  found  in  the  case  of  the  insurance  company 
which  receives  payments  for  insurance  premiums  which  do  not 
expire  during  the  current  period;  in  the  case  of  a  publishing  concern 
which  receives  subscriptions  to  its  publication,  paid  in  advance,  for 
a  period  of  time  which  runs  past  the  end  of  the  current  fiscal  period; 
and  in  the  case  of  a  commercial  bank  which  discounts  the  note  of  a 
customer,  deducting  in  advance  the  amount  of  the  interest,  which 
may  be  for  a  period  which  runs  beyond  the  end  of  the  year. 


314 


PRINCIPLES  OF  ACCOUNTING 


The  case  of  the  commercial  bank  may  be  used  for  an  illustration. 
When  the  bank  discounts  a  customer's  note,  an  entry  would  be  made 
debiting  Loans  and  Discounts  for  the  face  of  the  note,  crediting  the 
customer,  or  possibly  Cash,  for  the  proceeds  of  the  note,  and  crediting 
Discount  Earned  for  the  amount  of  the  interest  or  discount  deducted. 
At  the  end  of  a  fiscal  period  this  account  will  show  a  credit  balance, 
including  not  only  all  the  discount  earned  during  the  period  but  also 
a  considerable  amount  that  will  not  be  earned  until  some  time  in  the 
following  period.  At  the  end  of  a  fiscal  period,  if  the  proprietorship 
in  the  bank  and  its  income  for  the  period  are  to  be  shown  correctly, 
it  will  be  necessary  to  show  as  income  only  that  portion  of  the  dis- 
counts which  have  been  earned  within  the  period,  and  to  show  the 
unearned  discounts  on  the  balance  sheet  as  a  deferred  credit  to  income. 

NOTES  DISCOUNTED  RECORD 


Date 
Dis- 
counted 

Maker  of  Note 
or 
Acceptor  of  Draft 

Indorser  of  Note 
or 
Drawer  of  Draft 

Date 
Dis- 
counted 

Date 
of 
Maturity 

Discount 
Rate 

Amount 
of 
Note 

When 
Paid 

NOTES  DISCOUNTED  RECORD 


EXPIRATIONS  OT  INTEREST 


AMOUNT 


Jan. 

Feb. 

Mar. 

April 

May 

June 

July 

Aug. 

Sept. 

Oct. 

Nov. 

Dec. 

FORWARD 

Certain  classes  of  banks  are  now  required  by  the  federal  examiners 
to  show  the  amount  of  discounts  unearned  as  an  item  on  the  balance 
sheet.  The  accounting  departments  of  many  of  them  objected  to  this 
because  of  the  tremendous  amount  of  work  involved  in  classifying 
the  notes  and  dividing  the  discount  deducted  as  between  earned  and 
unearned.  The  work  required  for  this  may  be  minimized  by  the  use 
of  a  record  along  the 'lines  of  the  insurance  policy  record  illustrated 


ACCRUALS  AND  DEFERRED  ITEMS 


315 


above.  Such  a  form  would  need  to  provide  for  certain  essential 
information  about  each  note,  draft,  or  trade  acceptance  discounted, 
and  also  to  show  an  analysis  by  months  of  the  discount  earned.  The 
information  needed  would  probably  be  about  as  given  on  page  314. 
.  Such  a  record  as  this,  modified  in  any  way  necessary  to  fit  the 
needs  of  the  bank  using  it,  would  furnish  the  information  necessary 
to  divide  the  Discount  Earned  during  a  given  fiscal  period  from  that 
unearned.  An  entry  would  then  be  made  at  the  end  of  the  period 
debiting  Discounts  Earned  and  crediting  Discounts  Unearned  for  the 
amount  of  discounts  shown  by  this  record  to  be  unexpired  at  the  end 
of  the  period.  The  two  accounts,  used  in  this  manner,  would  be 
debited  and  credited  as  follows: 

DISCOUNT  EARNED 


Debit: 

At  the  end  of  the  period  with  the 
amount  of  discount  unearned. 


Credit: 
With  the  amount  of  discount  deducted 

when  the  note  or  draft  is  discounted. 
At  the  beginning  of  a  new  period  with 

the  balance  of  discount  unearned 

account. 


DISCOUNT  UNEARNED 


Debit: 

At  the  beginning  of  a  new  period  with 
the  amount  of  the  balance,  to 
transfer  back  to  discount  earned 
account. 


Credit: 

At  the  end  of  a  period  with  the  amount 
of  discount  unexpired. 


The  foregoing  represents  the  method  by  which  most  of  the  banks 
seem  to  have  handled  these  two  accounts.  A  more  logical  method, 
which  would  avoid  the  necessity  of  closing  discounts  unearned  back 
into  discounts  earned  account  at  the  beginning  of  each  period,  would 
be  to  debit  and  credit  these  accounts  as  follows: 

DISCOUNT  UNEARNED 


Debit: 

At  the  end  of  each  month  with  all 
amounts  of  discounts  expired,  as 
shown  by  the  notes  discounted 
record. 


Credit: 

With  the  amounts  of  all  discounts 
received  on  notes  and  drafts 
discounted. 


316 


PRINCIPLES  OF  ACCOUNTING 
DISCOUNT  EARNED 


Debit: 
With  closing  entry  (to  profit  and  loss). 


Credit: 

At  the  end  of  the  month  with  all 
amounts  of  discounts  expired,  as 
shown  by  the  notes  discounted 
record. 


Other  types  of  payments  received  by  a  business  in  advance  of  the 
rendering  of  the  service  by  the  business  may  be  handled  in  the  same 
manner.  Where  any  considerable  number  of  such  payments  are 
received,  it  is  highly  desirable  that  some  sort  of  supplementary 
record  should  be  maintained  to  show  at  any  time  what  portion  of 
this  income  has  been  earned  and  what  portion  is  still  unearned. 
The  amount  of  all  such  receipts  should  be  credited  to  an  unearned  in- 
come account  and  transferred  from  this  account  to  an  appropriate 
income  account,  as  the  supplementary  record  shows  them  to  have 
become  earned  income. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  The  Fashion  Publishing  Company  issues  a  magazine,  Modes.     Sub- 
scriptions are  all  paid  in  advance.    They  are  made  and  renewed  at 
various  times  throughout  the  year,  being  paid  for  periods  of  one,  two, 
or  three  years.    Outline  the  method  which  you  should  recommend  for 
accounting  with  this  source  of  income.     Should  you  employ  any  special 
types  of  records  ? 

Give  the  journal  entries  which  would  be  necessary  to  adjust  this  matter 
at  the  end  of  the  fiscal  year. 

2.  The  Fashion  Publishing  Company  issues  with  each  copy  of  its  maga- 
zine a  coupon  good  for  a  pattern.    These  patterns  are  available  at 
various  stores  throughout  the  United  States.    What  is  the  nature  of 
the  accounting  problems  to  which  this  practice  would  give  rise  ? 

3.  On  December  2  the  firm  of  Taylor  and  Wilson  discounts  its  sixty -day 
note  for  $1,000.00  at  the  bank,  the  rate  being  6  per  cent.    On  December 
15  the  firm  gives  a  trade  creditor  its  thirty-day  note  for  $1,500.00,  with 
interest  at  6  per  cent.    The  fiscal  period  ends  December  31. 

a)  What  journal  entries  should  be  made  when  each  of  these  notes  was 
issued  ? 

b)  What  journal  entries  affecting  the  interest  on  notes  payable  account 
should  be  made  at  the  end  of  the  fiscal  period?    What  term  or 

%  terms  may  be  used  to  characterize  these  entries  ? 

c)  What  entries  should  be  made  when  each  of  these  notes  matures  ? 


ACCRUALS  AND  DEFERRED  ITEMS          317 

4.  Explain  the  purpose  of  the  "post-closing"  entries,  in  the  case  of  (a) 
accrued  expense;  (b)   accrued   income.    What  difference   would  the 
omission  of  such  entries  make  in  the  later  accounting?    Illustrate  by 
means  of  skeleton  accounts. 

5.  Taylor  and  Wilson  have  in  their  ledger  an  account  with  "Office  Sup- 
plies," which  is  debited  with  all  purchases  of  such  supplies.     Explain 
two  methods  by  which  this  account  may  be  adjusted  at  the  end  of  a 
fiscal  period.    Illustrate  by  means  of  skeleton  ledger  accounts.    Would 
either  of  these  methods  necessitate  the  use  of  "post-closing"  entries? 
Have  you  a  preference  as  between  the  two  methods  ?    Discuss. 

6.  Explain    the    significance    of    the    item    "Discount    Received    but 
Unearned,"  which  appears  on  the  balance  sheet  of  a  certain  bank. 
What  journal  entries  are  necessary  to  adjust  this  account  at  the  close 
of  the  fiscal  period  ? 

7.  The  Federal  Income  Tax  law  allows  an  individual  the  option  of  report- 
ing his  income  and  expense  on  either  a  "cash"  basis,  or  an  "accrual" 
basis.     Explain. 

8.  Under  what  circumstances  should  you  consider  it  more  desirable  to 
use  the  cash  basis  in  reporting  ?    The  accrual  basis  ? 

REFERENCES  FOR  FURTHER  STUDY 

ESQUERRE,  PAUL- JOSEPH,  Applied  Theory  of  Accounts,  chaps,  xxv  and 

xxvi. 

WILDMAX,  J.  R.,  Principles  of  Accounting,  chaps,  xxvii  and  xlv. 
KESTER,  ROY  B.,  Accounting  Theory  and  Practice,  Vol.  I,  chap.  xvi. 


CHAPTER  XXVIII 

ADJUSTING  AND  CLOSING  ENTRIES 

Need  for  such  entries.  It  has  been  repeatedly  pointed  out  that  a 
business  concern  reports  on  its  financial  condition  or  on  the  success  of 
its  operations  at  the  end  of  certain  fiscal  periods,  or  accounting  periods. 
The  length  of  the  period  is  set  by  the  management,  and  may  be  a 
month,  three  months,  six  months,  a  year,  or  any  tune  that  seems  best. 
The  fiscal  period  was  formerly  generally  set  at  one  year,  and  usually 
began  and  ended  with  the  calendar  year.  The  increased  importance 
attached  to  the  use  of  the  reports  as  an  aid  in  management  has  had 
the  effect  of  shortening  the  fiscal  period  in  a  great  many  businesses, 
so  that  a  reporting  period  of  one  month  is  not  at  all  unusual.  At  the 
end  of  the  fiscal  period,  whatever  its  length,  it  is  the  practice  to  bring 
the  information  in  the  accounts  up  to  date  in  order  to  make  the 
accounts  state  as  correctly  as  possible  the  operations  of  the  period  just 
ended,  and  the  status  of  the  business  as  on  the  last  day  of  that  period. 
This  information  is  set  forth  in  the  balance  sheet  and  the  statement 
of  profit  and  loss  prepared  at  that  time,  and  the  various  revenue 
accounts  are  summarized  in  the  ledger  to  show  the  net  effect  of  the 
period's  operations  on  the  proprietorship  of  the  business.  Making 
such  a  summary  is  known  as  the  process  of  "closing  the  ledger." 
It  is  explained  hi  full  at  a  later  point  in  this  chapter. 

In  order  to  make  the  accounts  show  complete  and  correct  infor- 
mation at  the  end  of  the  period,  it  is  necessary  to  record  certain  facts 
which  for  one  reason  or  another  have  not  been  recorded  in  the  regular 
routine  of  entering  business  transactions.  For  example,  recognition 
must  be  given  to  the  fact  that  a  certain  amount  of  depreciation  on 
the  fixed  assets  is  chargeable  against  the  income  of  the  period,  and 
the  value  of  the  assets  affected  must  be  adjusted  on'  this  basis.  The 
estimated  loss  on  bad  debts  which  is  to  be  charged  against  the  income 
of  the  period  must  be  entered,  and  a  revaluation  made  of  current 
receivables  on  the  basis  of  this  estimate.  Recognition  must  be  given 
in  the  accounts  to  items  of  accrued  income,  accrued  expense,  deferred 

318 


ADJUSTING  AND  CLOSING  ENTRIES 


319 


charges  to  expense,  and  deferred  credits  to  income,  if  such  items  exist. 
The  adjustment  of  the  accounts  to  show  such  facts  necessitates  the 
making  of  certain  adjusting  entries  at  the  close  of  the  period. 

The  working  sheet.  Before  making  the  adjusting  entries  at  the 
end  of  a  period,  it  is  customary  to  post  all  the  ledger  accounts  to  date 
and  take  a  trial  balance.  This  trial  balance  shows  the  condition  of 
the  accounts  as  affected  by  the  current  transactions  for  the  period. 
The  trial  balance  cannot  be  used  for  preparing  the  financial  reports, 
however,  until  the  necessary  adjusting  entries  have  been  made.  To 
facilitate  the  making  of  these  adjustments  the  accountant  frequently 
makes  use  of  the  working  sheet,  by  means  of  which  he  is  able  to  sum- 
marize the  information  which  is  to  go  into  the  reports.  It  is  a  form 
used  for  scheduling  or  tabulating  the  information  in  question,  and 
consists  of  the  trial  balance  and  six  or  more  additional  columns. 
The  columns  needed,  and  their  purpose,  may  be  seen  from  the 

following  form: 

WORKING  SHEET 


TRIAL  BALANCE 

ADJUSTMENTS 

PROFIT  AND  Loss 

BALANCE  SHEET 

Name 
of 
Account 

Debits 

Credits 

Debits 

Credits 

Debits 

Credits 

Debits 

Credits 

The  names  of  the  accounts  involved  appear  first  at  the  left-hand  side 
of  the  page.  The  first  two  money  columns  show  the  trial  balance  as 
taken  from  the  books  after  they  are  posted  at  the  end  of  the  fiscal 
period.  The  next  two  columns,  headed  "Adjustments,"  show  the 
adjustments  which  must  be  made  to  the  various  accounts  hi  order 
to  bring  them  up  to  date  for  reporting  purposes.  The  two  columns 
headed  "Profit  and  Loss"  show  the  items  which  will  appear  in  the 
statement  of  profit  and  loss,  classified  according  to  their  effect  on  net 
income.  The  two  "Balance  Sheet"  columns  show  the  items  which 
will  appear  in  the  balance  sheet,  the  left-hand  side  showing  the  assets, 
and  the  right-hand  side  showing  liabilities,  asset  valuation  accounts, 
and  proprietorship  items. 

Illustration  of  the  working  sheet.    The  use  of  the  working  sheet  may 
be  simply  illustrated.    Assume  that  John  Haynes  is  conducting  a 


320  PRINCIPLES  OF  ACCOUNTING 

retail  business,  and  that  the  fiscal  period  is  one  month.  After  the 
posting  has  been  done  at  the  end  of  the  month,  a  trial  balance  is 
taken,  which  is  as  follows: 

JOHN  HAYNES 
TRIAL  BALANCE,X  JULY  31,  1920 

Cash $  5,120.00 

Accounts  Receivable        ....       15,990.00 

Notes  Receivable 4,000.00 

Merchandise  Inventory  (June  i)    .       .       11,500.00 

Store  Equipment 725.00 

Reserve  for  Depreciation  Store  Equipment .       .       .     $      125.00 

Delivery  Equipment        ....         1,500.00 

Reserve  for  Depreciation  Delivery  Equipment    .       .  300.00 

Accounts  Payable 8,140.00 

Notes  Payable 9,000.00 

Purchases 19,600.00 

Purchases  Returns  and  Allowances       ....  650.00 

Freight  and  Cartage  Inward  .       .       .  220.00 

Sales 23,625.00 

Sales  Returns  and  Allowances        .       .  460.00 

Sales  Salaries 1,500.00 

Advertising 220.00 

Delivery  Expense 190.00 

Rent 300.00 

Insurance  Prepaid  (to  end  of  year)       .  120.00 

Heat  and  Light 56.00 

Cash  Discount  on  Purchases          .....  245.00 

John  Haynes,  Capital 19,466.00 

John  Haynes,  Personal    ....  50.00 

$61,551.00      $61,551.00 


SUPPLEMENTARY  DATA 

1.  Inventories: 

Merchandise  inventory,  July  31,  $13,000.00 

2.  Depreciation: 

Store  equipment,  12  per  cent 
Delivery  equipment,  18  per  cent 

3.  Reserve  for  bad  debts: 

One-fifth  of  i  per  cent  on  accounts  receivable 

1  This  trial  balance  is  not  to  be  taken  as  representing  a  desirable  or  repre- 
sentative classification  of  accounts.  ¥he  thing  to  be  illustrated  here  is  the  method 
employed  in  summarizing  the  accounts  at  the  close  of  the  period.  • 


ADJUSTING  AND  CLOSING  ENTRIES  321 

4.  Deferred  charges: 
Coal  on  hand,  $17.00 

Gasoline  and  auto  supplies,  $30.00 

Insurance  has  expired  to  the  amount  of  $20.00 

5.  Accrued  expense: 
Salaries  accrued,  $90.00 
Interest  on  notes  payable,  $18.00 

6.  Accrued  income: 

Interest  on  notes  receivable,  $12.00 

The  adjusting  entries.  The  journal  entries  which  will  be  necessary 
to  adjust  the  accounts  to  give  recognition  to  the  additional  data 
listed  above  are  as  follows: 

July  31 

Purchases $11,500.00 

Merchandise  Inventory $11,500.00 

To  close  the  beginning  inventory  into  Purchases  account 

3i 
Merchandise  Inventory    ....       13,000.00 

Purchases 13,000.00 

To  enter  the  inventory  as  at  July  31 

3i 
Depreciation  on  Store  Equipment  .       .  7.25 

Reserve  for  Deprecation  Store  Equipment     .       .  7.25 

To  enter  period's  depreciation  on  store  equipment 

3i 
Delivery  Expense      .       .       .       .       .  22.50 

Reserve  for  Depreciation  on  Delivery  equipment  22.50 

To  enter  period's  depreciation  on  delivery  equipment 

3i 
Loss  from  Bad  Debts        ....  30.00 

Reserve  for  Bad  Debts 30.00 

To  enter  estimated  loss  from  bad  debts 

3i 
Supplies  Inventory1          ....  47 .00 

Heat  and  Light         .       .       .       .       .       .       .  17.00 

Delivery  Expense 30.00 

To  enter  deferred  charge  for  supplies  inventory  and  adjust 

expense  for  the  period 

1  Another  method,  illustrated  in  the  preceding  chapter,  would  probably  be 
preferable  here,  but  would  involve  a  different  arrangement  of  accounts  in  the  trial 
balance.  This  method  would  be  that  of  charging  purchases  of  supplies  to  the 
supply  accounts,  and  at  the  end  of  the  period  crediting  the  supply  accounts  and 
debiting  the  expense  accounts. 


322  PRINCIPLES  OF  ACCOUNTING 

31 
Insurance   .......  $20.00 

Insurance  Prepaid     .......  $20.00 

To  record  insurance  expired  for  the  period 


Sales  Salaries     ......  90.00 

Salaries  Accrued       .......  90.00 

To  record  accrued  sales  salaries 


Interest  on  Notes  Payable      .       .       .  18.00 

Interest  Accrued  Payable       .....  18.00 

To  record  interest  accrued  on  notes  payable 

31 
Interest  Accrued  Receivable  .       .       .  12.00 

Interest  on  Notes  Receivable         .       .       .       .  12.00 

To  record  interest  accrued  on  notes  receivable 

The  trial  balance,  the  adjustments  to  be  made  on  the  accounts  as 
there  shown,  and  the  disposal  of  the  adjusted  balances  as  between  the 
balance  sheet  and  the  statement  of  profit  and  loss,  can  all  be  sum- 
marized on  the  working  sheet,  on  page  323. 

The  statement  of  profit  and  loss.  When  the  working  sheet  is  com- 
pleted, the  accountant  has  before  him  a  summary  of  the  accounts, 
corrected  to  show  the  true  condition  of  the  business  at  the  end  of  the 
period.  He  is  then  ready  to  prepare  the  financial  statements  from 
the  information  furnished  by  this  schedule.  The  corrected  balances 
of  the  accounts  affecting  the  statement  of  profit  and  loss  have  been 
carried  into  the  two  columns  headed  "Profit  and  Loss,"  and  those 
affecting  the  balance  sheet  are  carried  into  the  two  columns  headed 
"Balance  Sheet."  The  profit  and  loss  columns  and  the  balance  sheet 
columns  are  then  totaled  to  make  sure  that  the  excess  of  the  credit 
column  under  "Profit  and  Loss"  over  the  debit  columns,  showing  the 
net  profit  for  the  period,  is  the  same  in  amount  as  the  excess  of  the 
debit  column  under  "Balance  Sheet"  over  the  credit  column  under 
that  heading,  this  excess  also  representing  the  increase  in  proprietor- 
ship, or  net  profit  for  the  period.  The  statement  of  profit  and  loss 


ADJUSTING  AND  CLOSING  ENTRIES 


323 


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324  PRINCIPLES  OF  ACCOUNTING 

may  then  be  prepared  from  the  items  appearing  in  the  profit  and  loss 
columns,  as  follows: 

JOHN  HAYNES 
STATEMENT  OF  PROFIT  AND  Loss  FOR  MONTH  ENDING  JULY  31,  1920 

Gross  Sales $23,625.00 

Less  Returns  and  Allowances     ...       .       .       .  460.00 


Net  Sales 23,165.00 

Cost  of  Goods  Sold: 

Gross  Purchases $19.600.00 

Less  Returns  and  Allowances .       .  650.00 


Net  Purchases       .       .       .  .       18.050.00 

Freight  and  Cartage  Inward      .       .  220.00 

Inventory,  July  i,  1920       .       .       .       11,500.00 

30.670.00 
Less  Inventory,  July  31,  1920    .       .       13,000.00 


Cost  of  Goods  Sold 17,670.00 


Gross  Profit  on  Sales 5,495.00 

Operating  Expenses: 
Selling  Expenses: 
Sales  Salaries     .  .       $1,5^0.00 
Advertising        .  .  220.00 
Depreciation  Store  Equip- 
ment      .       .  .  7.25 


Total  Selling  Expense  .       .       .         1,817.25 

Delivery  Expense     .  .       .       .  182.50 

Administrative  Expense: 
Rent    ....  300.00 

Insurance   .       .       .  20.00 

Heat  and  Light.       .  39.00 

Loss  from  Bad  Debts  30.00 


Total  Administrative  Expense    .  389.00 

Total  Operating  Expense 2,388.75 

Net  Operating  Profit 3,106.25 


ADJUSTING  AND  CLOSING  ENTRIES  325 

Other  Income: 

Interest  on  Notes  Receivable     .       .       $     12.00 
Cash  Discount  on  Purchases      .       .  245.00 

Total  Other  Income.        ......$    257.00 

Gross  Income 3,363-25 

Deductions  from  Income: 

Interest  on  Notes  Payable  .       .       .  18.00 

Total  Deductions  from  Income      ....  18.00 

Net  Income $3>345-25 

The  balance  sheet.    From  the  items  appearing  in  the  balance  sheet 
columns,  the  following  balance  sheet  may  be  prepared: 

JOHN  HAYNES 
BALANCE  SHEET,  AS  OF  JULY  31,  1920 

ASSETS 

Current  Assets: 

Cash $  5,120.00 

Notes  Receivable 4,000.00 

Accounts  Receivable    .     $15,990.00 
Less  Reserve  for  Bad  Debts    30.00        1 5,960.00 


Merchandise  Inventory       .        .        .       13,000.00 
Interest  Accrued  on  Notes  Receivable  12.00 


Total  Current  Assets $38,092.00 

Fixed  Assets: 

Store*  Equipment  .       .  725.00 

Less  Reserve  for  De- 
preciation      .       .  132.25  592.75 


Delivery  Equipment     .         1,500.00 
Less  Reserve  for  De- 
preciation      .       .  322.50          1,177.50 


Total  Fixed  Assets 1,770.25 

Deferred  Charges  to  Expense: 
Insurance  Prepaid        ....  100.00 

Supplies  Inventory       ....  47 .00 

Total  Deferred  Charges 147.00 

Total  Assets $40,009.25 


326  PRINCIPLES  OF  ACCOUNTING 

LIABILITIES   AND   PROPRIETORSHIP 

Current  Liabilities: 

Notes  Payable $  9,000.00 

Accounts  Payable         ....  8,140.00 

Salaries  Accrued 90.00 

Interest  Accrued  on  Notes  Payable  .  18.00 


Total  Current  Liabilities     .       .       .       .       .  $17,248.00 

Proprietorship: 

John  Haynes,  Proprietor     ......  22,761.25 

Total  Liabilities  and  Proprietorship  .       .       .  $40,009.25 


The  closing  entries.  An  examination  of  the  profit  and  loss  columns 
of  the  working  sheet  shows  what  accounts  must  be  closed  in  order  to 
summarize  the  results  of  the  period's  operations.  Those  columns 
show  the  revenue  accounts  which  still  have  balances,  and  the  amount 
of  each  such  balance  after  the  adjusting  entries  are  made  and  posted. 
Taking  the  balances  of  the  revenue  accounts  as  they  appear  on  the 
working  sheet  after  being  adjusted,  the  closing  entries  necessary  to 
summarize  them  are  as  follows: 

July  31 
Purchase  Returns  and  Allowances.       .        $  650.00 

Purchases $650.00 

To  close  purchases  returns  and 
allowances  account  into  pur- 
chases account 

31 

Purchases 220.00 

Freight  and  Cartage  Inward 220.00 

To  transfer  in-freight  to  pur- 
chases account,  as  part  of  the  cost 
of  goods  sold 

31 

Sales 460.00 

Sales  Returns  and  Allowances        ....  460.00 

To  close  sales  returns  and  allow- 
ances account  into  sales  account 


ADJUSTING  AND  CLOSING  ENTRIES 


327 


Sales 


$17,670.0x3 


Purchases 

To  close  purchases  account  and 
transfer  the  cost  of  goods  sold  to 
the  debit  of  sales 


$17,670.00 


Sales 5,495-oo 

Profit  and  Loss 5495.00 

To  close  sales  account  and  trans- 
fer the  gross  profit  on  sales  to 
profit  and  loss  account 

31 

Profit  and  Loss 2,358.75 

Sales  Salaries 1,500.00 

Advertising 220.00 

Depreciation  on  Store  Equipment.       .       .       .  7.25 

Delivery  Expense 182.50 

Rent 300.00 

Insurance 20.00 

Heat  and  Light 39-oo 

To  close  the  operating  expense 

accounts  and  transfer  their  total 

to  the  debit  of  profit  and  loss 

account 

31 

Interest  on  Notes  Receivable .  .  .  12.00 

Cash  Discount  on  Purchases  .  .  .  245.00 

Profit  and  Loss 257.00 

To  transfer  the  balances  of  the 

non-operating    income    accounts 

to  profit  and  loss 

31 

Profit  and  Loss 48.00 

Interest  on  Notes  Payable 18.00 

Loss  from  bad  debts 30.00 

To  close  the  non-operating  ex- 
pense accounts  and  transfer  their 
balances  to  profit  and  loss 


328  PRINCIPLES  OF  ACCOUNTING 

31 

Profit  and  Loss $3,345-25 

John  Haynes,  Capital $3,345-25 

To  close  profit  and  loss  account 
and  transfer  the  net  profit  for  the 
fiscal  period  to  the  proprietor's 
capital  account 

31 
John  Haynes,  Capital      ....  50.00 

John  Haynes,  Personal 50.00 

To  transfer  the  balance  of  the 
proprietor's  personal  account  to 
his  capital  account 

After  these  "  closing  "  entries  have  been  posted,  and  all  the  accounts 
which  are  in  balance  ruled  to  indicate  that  fact,  the  accounts  which 
will  still  remain  open  and  show  balances  will  be  only  the  asset  accounts, 
liability  accounts,  and  the  proprietor's  capital  account.  The  infor- 
mation furnished  by  the  balances  of  the  accounts  remaining  open  in 
the  ledger  will  be  exactly  the  same  as  that  furnished  by  the  balance 
sheet  at  the  close  of  the  period,  as  illustrated  on  page  325. 

The  post-closing  entries.  In  the  chapter  on  "Accruals  and  De- 
ferred Items,"  it  was  explained  that  it  was  customary  to  transfer  the 
amount  of  accrued  items  back  to  the  appropriate  income  or  expense 
accounts  after  the  books  had  been  closed.  The  reasons  for  such 
transfers  were  explained  in  that  chapter,  along  with  the  effect  in 
correcting  the  balance  of  the  income  or  expense  account  affected  with 
respect  to  its  showing  for  the  coming  period.  In  the  case  of  the  busi- 
ness of  John  Haynes,  there  are  three  accruals  to  be  considered: 
(i)  accrued  interest  receivable,  (2)  accrued  interest  payable,  and 
(3)  accrued  salaries.  The  supplies  inventory  account  must  also  be 
closed  back  into  the  expense  accounts  that  were  credited  when  it  was 
set  up.  This  is  an  awkward  feature  of  the  method  of  adjustment 
used  for  those  deferred  charges,  and  could  have  been  avoided  by  a 
better  arrangement  of  the  accounts,  as  was  previously  explained. 
The  entries  necessary  to  close  these  accounts  are  as  follows: 


ADJUSTING  AND  CLOSING  ENTRIES  329 

31 
Interest  on  Notes  Receivable  .        .       .  $12.00 

Interest  Accrued  Receivable $12.00 

To  close  the  interest  accrued 
receivable  into  the  interest  on 
notes  receivable  account 

3i 
Interest  Accrued  Payable        .       .       .  18.00 

Interest  on  Notes  Payable 18.00 

To  close  the  interest  accrued 
payable  into  the  interest  on  notes 
payable  account 

31 

Delivery  Expense 30.00 

Heat  and  Light 17.00 

Supplies  Inventory 47-oo 

To  close  the  deferred  charge 
account  into  the  expense  ac- 
counts affected 

3i 

Salaries  Accrued 90.00 

Sales  Salaries .        .  90.00 

To  close  the  salaries  accrued  into 
the  sales  salaries  account 

The  post-dosing  trial  balance.  It  has  been  explained  that  at  the 
end  of  a  fiscal  period  a  preliminary  trial  balance  is  taken  to  make  sure 
that  there  is  an  equality  between  the  debits  and  credits  which  have 
been  posted  to  the  accounts.  Adjustments  to  the  accounts  as  shown 
by  that  trial  balance  are  then  made,  on  the  basis  of  such  supplementary 
information  as  is  obtainable,  by  means  of  adjusting  entries  in  the 
journal,  which  are  posted  to  the  accounts.  The  accounts  are  then 
summarized  to  show  the  result  of  the  period's  operations  by  means  of 
the  closing  entries,  after  which  the  accrued  items  are  carried  back  to 
the  revenue  accounts  to  which  they  pertain  by  means  of  post-closing 
entries.  In  order  to  insure  to  some  extent  the  accuracy  of  all  these 
entries,  at  least  to  the  extent  of  an  equality  between  their  debits  and 
credits,  it  is  customary  to  take  a  post-closing  trial  balance  before 
proceeding  with  the  entries  of  the  following  period.  Such  a 


336  PRINCIPLES  OF  ACCOUNTING 

post-closing   trial  balance  taken  from  the  ledger  of  John  Havnes 
would  appear  as  follows: 

JOHN  HAYNES 
POST-CLOSING  TRIAL  BALANCE,  JULY  31,  1920 

Cash $  5,120.00 

Accounts  Receivable        ....       15,990.00 
Notes  Receivable      .       .       .       .  4,000.00 

Merchandise  Inventory   ....       13,000.00 

Store  Equipment 725.00 

Reserve  for  Depreciation  on  Store  Equipment    .       .     $      132.25 

Delivery  Equipment        ....         1,500.00 

Reserve  for  Depreciation  on  Delivery  Equipment.    .  322.50 

Accounts  Payable 8,140.00 

Notes  Payable 9,000.00 

Sales  Salaries 90.00 

Insurance  Prepaid 100.00 

John  Haynes,  Capital 22,761.25 

Reserve  for  Bad  Debts 30.00 

Delivery  Expense 30.00 

Heat  and  Light         .       .       .       .       .  17.00 

Interest  on  Notes  Payable 18.00 

Interest  on  Notes  Receivable .  12.00 


$40,494.00      $40.494.00 


When  the  equality  of  the  debits  and  credits  has  been  ascertained 
by  means  of  a  post-closing  trial  balance  like  the  one  shown  above,  the 
ledger  is  then  ready  to  have  posted  to  it  the  transactions  of  the  new 
accounting  period. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  Assuming  any  type  of  business  you  please,  make  a  list  of  facts  concern- 
ing that  business  which  would  necessitate   ten  different  adjusting 
entries  at  the  end  of  the  fiscal  period,  and  give  the  entries. 

2.  Outline  step  by  step  the  order  of  procedure  which  you  would  follow 
in  "closing  the  books"  and  preparing  the  financial  statements  of  a 
business  at  the  end  of  its  fiscal  period.    Justify  the  order  indicated  in 
your  answer. 

3.  Under  what  circumstances  would  it  be  worth  while  to  include  in  the 
working  sheet  an  "adjusted  trial  balance"  ? 


ADJUSTING  AND  CLOSING  ENTRIES 


331 


4.  From  the  information  shown  by  the  working  sheet  in  the  illustrative 
exercise  in  chapter  xxviii,  construct  journal  entries  necessary  to  set  up 
a  summary  account  headed  "Trading,"  the  balance  of  which  shall 
represent  the  gross  trading  profit  for  the  period,  and  to  close  this 
account  into  profit  and  loss. 

5.  What  journal  entries  would  be  necessary  to  record  the  following: 

o)  An  appropriation  of  the  net  earnings  of  a  corporation  for  dividends 
amounting  to  $7,500.00? 

b)  An  appropriation  of  earnings  for  the  addition   of  $5,000.00  to 
reserve  for  redemption  of  bonds  ? 

c)  An  appropriation  of  earnings  to  the  amount  of  $10,000.00  for  the 
purpose  of  reducing  the  amount  of  discount  on  stock  ? 

6.  Should  you  always  use  a  working  sheet  in  preparing  the  statements  at 
the  end  of  a  fiscal  period?    If  not,  under  what  circumstances  might 
you  dispense  with  its  use  ? 

REFERENCES  FOR  FURTHER  STUDY 

ESQUERRE,  PAUL-JOSEPH,  Applied  Theory  of  Accounts,  chap,  xxxiv. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  chaps. 

viii  and  ix. 

KLEIN,  J.  J.,  Elements  of  Accounting,  chap.  ix. 
HATFIELD,  H.  R.,  Modern  Accounting,  chap.  xv. 

LABORATORY  EXERCISE  NO.  34 

The  following  trial  balance  was  taken  from  the  books  of  the  Moore  & 
Smith  Hardware  Company,  December  31,  1919: 


Cash  on  hand  .... 
Cash  in  bank  .... 

Sales 

Discounts  on  purchases  7       . 
Interest  on  notes  receivable    . 
Accounts  receivable  . 
Notes  receivable 
Capital  stock  (common)  . 
Real  estate        .... 

Buildings 

Equipment  .... 
Horses,  wagons,  and  harness  . 
Motor  trucks  .... 
Insurance  . 


DEBIT 

100.00 
3,000.00 


150,000.00 

10,000.00 

50,000.00 

200,000.00 

50,000.00 
5,000.00 
5,000.00 
2,000.00 


CREDIT 


$1,150,000.00 

20,000.00 

1,000.00 


200,000.00 


332 


PRINCIPLES  OF  ACCOUNTING 


DEBIT  CREDIT 

Taxes $    5,000.00 

Purchases 900,000.00 

Discounts  on  sales — cash  .  .  20,000.00 
Wages  of  men  in  warehouse  .  .  25,000.00 
Salaries  of  department  managers  .  10,000.00 
Salaries  of  office  assistants  .  .  5,000.00 

Drivers,  teamsters,  etc.    .       .       .  5,000.00 

Horse  feed 2,000.00 

Auto  expense 1,500.00 

Inventories,  January  i,  1919  .  .  300,000.00 
Inventories  of  horse  feed,  auto 

accessories,  etc.,  January  i,  1919  3,000.00 

Inventories  of   stationery,   adver- 
tising, etc.,  January  i,  1919       .  2,000.00 
Office  supplies,  stationery,  etc.       .            3.000.00 

Advertising 50,000.00 

Salesmen's  salaries  ....  20,000.00 
Salesmen's  commissions  .  .  .  11,000.00 
Interest  on  notes  payable  .  .  10,000.00 

Fund  for  payment  of  dividends     .          12,000.00 

Notes  payable $250,000.00 

Accounts  payable 138,000.00 

Dividends  payable 12,000.00 

Real  estate — not  used  in  business  150,000.00 
Investment  in  Union  Hotel  Com- 
pany (at  cost)       .       .       .       .  50,000.00 
Sprinkler  system — at  face  of  con- 
tract                  10,000.00 

Liability  on  sprinkler  system 8,000.00 

Surplus 290,600.00 

$2,069,600.00     $2,069,600.00 


On  December  31,  1919,  the  company  authorized  the  issue  of  $300,000.00 
cumulative  7  per  cent  preferred  stock  and  sold  same  to  the  Grand  Investment 
Company  -at  97.  $70,000.00  common  stock  was  sold  to  the  present  stock- 
holders at  par,  the  total  issue  of  common  stock  being  $270,000.00.  Of  the 
proceeds  of  these  sales  $150,000.00  was  to  be  expended  on  new  buildings, 
the  balance  to  be  retained  for  working  capital. 


ADJUSTING  AND  CLOSING  ENTRIES  333 

The  inventories  at  December  31,  1919,  were:    . 

Merchandise $325,000.00 

Horse  feed,  auto  accessories,  etc..       .       .          2,000.00 

Stationery,  advertising,  etc 1,500.00 

Of  the  insurance  paid,  $500.00  applies  to  the  year  1920;  also  $1,500.00 
of  the  taxes. 

Of  the  interest  $2,000.00  applies  to  the  period  subsequent  to  January  i, 
1920. 

The  depreciation  of  buildings  for  the  year  is  $10,000.00,  and  of  equip- 
ment, $5,000.00.    The  real  estate  not  used  in  business  has  appreciated 
$50,000.00,  while  that  used  in  business  has  been  appraised  at  $75,000.00. 
From  the  foregoing  trial  balance  and  data  prepare  and  submit: 

1.  Working  sheet. 

2.  Adjusting  and  closing  entries. 

3.  Balance  sheet. 

4.  Statement  of  profit  and  loss. 


CHAPTER  XXIX 

THE  CLASSIFICATION  OF  ACCOUNTS 

The  purpose  served  by  the  accounts.  It  has  been  repeatedly 
emphasized  that  the  accounts  are  the  means  of  analyzing  information 
concerning  the  financial  operations  and  status  of  the  business  in  such  a 
manner  as  to  make  this  information  available  for  reporting  purposes. 
The  account  has  been  defined  as  a  systematic  record  of  information 
pertaining  to  some  item  appearing  on  the  accounting  reports,  this 
information  being  arranged  under  an  appropriate  title.  Since  each 
account  contains  information  pertaining  to  some  item  which  is  to 
appear  on  the  reports,  the  number  of  the  accounts  and  the  basis  upon 
which  they  will  be  classified  and  subdivided  will  depend  in  every  case 
upon  the  nature  of  the  reports  desired  for  the  particular  business  and 
the  amount  of  detail  these  reports  are  to  contain.  In  other  words, 
the  items  with  which  accounts  will  be  carried  are  entirely  dependent 
on  the  items  to  be  shown  in  the  reports. 

The  reports  which  have  been  discussed  and  illustrated  up  to  this 
point  in  the  course  are  all  of  the  simplest  and  most  conventional  type. 
In  fact,  only  the  two  forms  which  are  in  almost  universal  use,  the 
balance  sheet  and  the  statement  of  profit  and  loss,  have  been  con- 
sidered. These  two  statements,  however,  furnish  information  con- 
cerning the  fundamental  facts  of  the  business — those  having  to  do 
with  the  status  of  the  investment  and  the  nature  and  net  result  of  the 
current  operations.  Any  other  reports  taken  directly  from  the  ac- 
counts must  consist  for  the  most  part  of  information  concerning  these 
same  facts,  reclassified  to  be  of  greater  assistance  to  some  functional 
manager,  or  to  show  more  detail  with  regard  to  some  particular  kind 
of  assets,  liabilities,  proprietorship,  or  some  phase  of  operations. 
It  is  true  that,  in  addition  to  the  reports  prepared  from  the  information 
shown  by  the  accounts,  there  may  also  be  some  very  useful  reports 
made  up  from  statistics  gathered  from  other  sources  and  not  appearing 
in  the  accounts. 

Since  the  accounting  reports  other  than  the  balance  sheet  and 
statement  of  profit  and  loss  are  mainly  rearrangements  or  elaborations 

334 


THE  CLASSIFICATION  OF  ACCOUNTS  335 

of  certain  facts  shown  in  one  or  the  other  of  these  two  statements,  the 
general  scheme  upon  which  the  accounts  will  be  classified  may  very 
well  follow  the  arrangement  of  the  items  in  these  two  general  reports. 
Whether  any  of  the  items  of  information  required  for  either  of  these 
two  statements  will  be  further  classified  in  the  accounts  will  depend 
on  the  nature  of  the  additional  accounting  reports  which  will  be  re- 
quired for  the  use  of  the  management  of  the  particular  business. 
In  the  following  discussion  it  will  be  impracticable  to  do  more  than 
suggest  the  possibility  of  such  sub-classifications,  and  the  classification 
shown  will  be  the  one  determined  by  the  form  of  the  balance  sheet  and 
the  statement  of  profit  and  loss. 

The  fundamental  classification  of  accounts.  There  is  certain  fun- 
damental information  which  the  owner  or  manager  of  any  business 
will  desire  to  have  available.  This  information  concerns:  (i)  the 
financial  condition  of  the  business,  which  is  shown  by  the  balance 
sheet,  and  (2)  the  nature  and  results  of  the  business  operations  for  the 
current  accounting  period,  which  is  shown  by  the  statement  of  profit 
and  loss.  In  view  of  these  facts  it  would  be  logical  to  assume  that 
the  fundamental  classification  of  accounts  should  be  twofold:  (i)  the 
accounts  reflecting  financial  condition,  which  appear  on  the  balance 
sheet;  and  (2)  the  accounts  reflecting  the  nature  and  results  of  business 
operations,  which  appear  in  the  statement  of  profit  and  loss.  This 
classification  of  accounts  into  balance  sheet  accounts  and  profit  and 
loss  accounts  is  one  that  is  used  by  several  writers  of  high  standing. 
The  first  class  of  accounts  is  ordinarily  designated  as  the  "real" 
accounts,  while  the  second  class  is  variously  designated  as  "nominal," 
"economic,"  and  the  "revenue"  accounts. 

Such  a  division  of  accounts  into  these  two  broad  classes  undoubt- 
edly exists,  but  this  classification  overlooks  the  very  important  point 
that  the  balance  sheet  items  are  divisible  into  two  classes,  each  of 
which  is  quite  distinct  in  its  nature,  and  each  of  which  is  co-ordinate 
in  rank  with  the  other,  and  with  the  revenue  group  of  accounts.  The 
first  of  these  two  classes  consists  of  these  accounts  which  show  the 
assets  owned  by  the  business  and  the  claims  which  creditors  hold 
against  those  assets;  and  the  accounts  of  this  group  may  therefore  be 
termed  the  property  accounts.  The  second  class  shows  the  net 
investment  in  the  business  of  the  proprietor  or  proprietary  group 
and  the  accounts  composing  this  class  maybe  termed  the  proprietorship 


336  PRINCIPLES  OF  ACCOUNTING 

accounts.  In  view  of  these  facts  it  would  seem  desirable  that  a 
threefold  classification  of  accounts  should  be  adopted,  as  follows: 
(i)  property  accounts;  (2)  proprietorship  accounts;  (3)  revenue 
accounts. 

To  one  who  has  followed  the  discussion  contained  in  the  previous 
chapters  of  the  use,  construction,  and  interpretation  of  accounts, 
this  classification  will  seem  a  perfectly  natural  and  logical  one. 
Property  accounts  include  accounts  with  assets,  showing  the  amount 
of  various  kinds  of  property  owned  by  the  business,  along  with  any 
valuation  accounts  used  to  show  corrections  on  the  value  of  such 
assets.  The  property  accounts  alsc  include  the  liability  accounts, 
which  show  the  claims  which  the  creditors  of  the  business  hold 
against  the  assets  of  the  business.  Proprietorship  accounts  include 
such  accounts  as  may  be  used  to  show  the  amount  of  the  net  proprie- 
torship of  the  business,  this  amount  being  the  difference  between 
its  total  assets  and  total  liabilities.  Revenue  accounts  include  all 
accounts  showing  the  amount  and  sources  of  different  types  of  income 
accruing  to  the  business  during  the  current  accounting  period,  as 
well  as  all  accounts  showing  the  amount  and  kinds  of  expenses  incurred 
in  securing  that  income,  and  all  deductions  to  be  made  from  it  before 
the  net  income  of  the  business  can  be  ascertained.  The  property 
accounts  and  proprietorship  accounts  furnish  the  information  which 
is  used  in  preparing  the  balance  sheet,  and  the  revenue  accounts 
furnish  the  information  shown  by  the  statement  of  profit  and  loss. 
These  three  main  classes,  with  their  subdivisions,  will  be  discussed  in 
the  order  in  which  they  have  been  listed. 

The  property  accounts.  As  explained  in  the  foregoing  paragraph, 
the  property  accounts  consist  of  the  accounts  which  show  the  value  of 
the  property,  or  assets,  owned  by  the  business,  and  of  the  accounts 
with  the  liabilites,  or  claims  outstanding  against  those  assets.  The 
two  main  groups  of  property  accounts,  then,  are  the  asset  accounts  and 
the  liability  accounts,  and  these  will  be  considered  in  that  order. 

The  classification  usually  shown  on  the  balance  sheet  for  the  asset 
accounts  is  as  follows:  (i)  current  assets;  (2)  deferred  charges  to 
income;  (3)  fixed  assets. 

The  liability  accounts  are  usually  shown  on  the  balance  sheet  in 
two  groups,  which  are  as  follows:  (i)  current  liabilities;  (2)  fixed 


THE  CLASSIFICATION  OF  ACCOUNTS    ^  337 

liabilities.  The  typical  accounts  with  both  these  classes  of  liabilities 
have  been  rather  fully  discussed  in  the  previous  chapters,  with  ref- 
erence to  the  nature  and  construction  of  the  accounts  involved,  and 
to  the  method  of  reporting  these  items  on  the  balance  sheet.  They 
will  require  no  further  discussion  at  this  point.  The  manner  in  which 
these  items  are  reported,  as  well  as  the  nature  of  the  accounts  included 
under  each  of  these  heads,  has  already  been  discussed  to  such  an 
extent  as  to  make  further  consideration  at  this  point  unnecessary. 

Illustration  of  the  property  accounts.  On  the  basis  of  the  funda- 
mental classification  indicated  in  the  present  chapter,  and  of  the 
discussion  of  the  nature  of  particular  accounts  given  in  earlier  chap- 
ters, an  outline  of  the  property  accounts  in  a  more  or  less  typical 
business  concern  may  be  drawn  up  as  follows: 

I.  Property  accounts 
A.  Assets  accounts 

1.  Current  assets 
a)  Cash 

ft)  Notes  Receivable 

(i)  Notes  Receivable  Discounted 

c)  Accounts  Receivable 

(i)  Reserve  for  Bad  Debts  (valuation  account) 

d)  Merchandise  Inventory 

e)  Accrued  Interest  Receivable 

2.  Deferred  charges 

a)  Prepaid  Advertising 
6)  Unexpired  Insurance 
c)  Inventory  of  Current  Supplies 

3.  Fixed  assets 

a)  Store  Equipment 

(i)  Reserve  for  Depreciation  of  Store  Equipment 
ft)  Delivery  Equipment 

(i)  Reserve  for  Depreciation  of  Delivery  Equipment 
c)  Office  Equipment 

(i)  Reserve  for  Depreciation  of  Office  Equipment 

f)  Buildings 

(i)  Reserve  for  Depreciation  on  Buildings 
e)  Land 


338  PRINCIPLES  OF  ACCOUNTING 

B.  Liability  accounts 

1.  Current  liabilities 

a)  Notes  Payable — Banks 

6)  Notes  Payable— Trade  Creditors 

c)  Accounts  Payable 

d)  Accrued  Wages 

e)  Accrued  Interest  Payable 

2.  Fixed  liabilities 

a)  Mortgages  Payable 

b)  Bonds  Payable 

This  list  of  acounts  is  intended  to  be  suggestive  rather  than 
exhaustive.  If  the  student  understands  clearly  the  basis  of  the 
classification,  he  should  have  no  difficulty  in  locating  hi  this  classi- 
fication the  proper  place  of  any  additional  items  which  he  may 
encounter  in  practice. 

The  proprietorship  accounts.  It  should  be  quite  clear  by  this  time 
that  the  proprietorship  accounts  are  the  accounts  which  represent  the 
amount  of  the  net  investment  of  the  owner  or  owners  of  the  business. 
This  is  the  excess  of  the  total  assets  over  the  total  liabilities.  In  a 
previous  chapter  dealing  with  the  construction  and  interpretation  of 
the  proprietorship  accounts  it  was  explained  that  the  individual  ac- 
counts with  proprietorship  will  differ  somewhat  in  their  nature 
according  to  the  form  of  organization  under  which  the  business  is 
carried  on.  The  three  common  forms  of  business  organization — 
the  single  proprietorship,  the  partnership,  and  the  corporation — were 
considered  with  respect  to  the  method  used  to  show  the  proprietorship 
of  each. 

In  the  case  of  a  single  proprieter,  two  such  accounts  will  ordinarily 
be  found  hi  use:  (i)  the  proprietor's  capital  account,  and  (2)  the 
proprietor's  personal  account.  It  was  explained  that  the  personal 
account  was  used  to  show  the  proprietor's  drawings  and  the  amount 
of  any  salary  allowance  with  which  he  might  credit  himself.  This 
account  is  usually  closed  in  to  the  capital  account  at  the  end  of  the 
accounting  period,  so  that  the  balance  sheet  of  the  single  proprietor 
will  usually  show  only  one  account  with  proprietorship. 

If  the  business  under  consideration  is  a  single  proprietorship, 
then,  the  proprietorship  group  of  accounts  will  be  very  simple,  and 
may  be  shown  as  follows: 


THE  CLASSIFICATION  OF  ACCOUNTS  339 

II.  Proprietorship  accounts 
a)  John  Haynes,  Capital 
i)  John  Haynes,  Personal 

In  the  partnership  there  will  be  a  capital  account  and  a  personal  or 
drawing  account  for  each  partner.  Sometimes  a  portion  of  the  part- 
nership profits  is  not  immmediately  distributed  to  the  partners' 
accounts,  but  is  carried  for  a  while  in  an  undivided  profits  account. 
Thus  if  the  business  used  for  illustration  were  a  partnership,  operating 
under  the  name  of  Adams  &  Jones,  the  partners  being  F.  A.  Adams 
and  P.  R.  Jones,  the  proprietorship  accounts  carried  might  be  as 
follows: 

II.  Proprietorship  accounts 

o)  F.  A.  Adams,  Capital 

fc)  F.  A.  Adams,  Personal 

c)  P.  R.  Jones,  Capital 

</)  P.  R.  Jones,  Personal 

e)  Undivided  Profits 

In  a  corporation  the  accounts  with  proprietorship  consist  of  the 
account  or  accounts  showing  the  capital  stock  outstanding,  at  its  par 
figure,  the  accounts  showing  the  amount  of  the  discount  or  pre- 
mium at  which  such  stock  was  actually  issued,  the  accounts  showing 
the  amount  of  net  earnings  which  have  been  appropriated  for  specific 
purposes,  and  the  amount  of  the  unappropriated  surplus,  or  pro- 
prietorship in  excess  of  the  par  of  capital  stock.  In  case  the 
investment  represented  by  the  par  of  the  stock  has  been  impaired  by 
operating  or  other  losses,  this  fact  will  be  reflected  by  a  deficit  account. 
If  the  business  used  for  illustration  were  the  Haynes  Company,  a 
corporation,  the  proprietorship  group  of  accounts  might  show  the 
following  accounts: 
II.  Proprietorship  accounts 

I.  Capital  Stock 

a)  Common  Stock 

(i)  Discount  on  Common  Stock1  (if  stock  issued  at  discount) 

b)  Preferred  Stock 

(i)  Discount  on  Preferred  Stock1  (if  stock  issued  at  discount) 

1  Discount  on  Stock  and  capital  Surplus  will  not  both  appear  on  the  same 
balance  sheet,  since  one  represents  a  deduction  from  the  par  of  the  capital  stock 
and  the  other  an  addition.  Where  some  stock  is  issued  at  a  premium  and  other 
at  a  discount,  the  two  will  be  offset  against  one  another,  and  only  the  net  result 
will  be  shown. 


340  PRINCIPLES  OF  ACCOUNTING 

2.  Reserves 

a)  Reserve  for  Addition  to  Plant 

5)  Sinking  Fund  Reserve 

c)  Reserve  for  Redemption  of  Bonds  • 

3.  Capital  Surplus  (if  stock  issued  at  a  premium) 

4.  Surplus 

The  revenue  accounts.  The  third  of  the  three  main  groups  into 
which  accounts  have  been  divided  by  the  classification  here  adopted 
is  that  of  the  revenue  accounts.  The  revenue  accounts,  as  previously 
stated,  consist  of  (i)  the  income  accounts,  which  show  the  sources  and 
amount  of  the  income  of  the  business  for  the  current  fiscal  period, 
and  (2)  the  expense  accounts,  which  show  the  kinds  and  amount  of  the 
expenses  incurred  in  the  process  of  securing  that  income. 

In  a  previous  chapter  on  the  construction  and  interpretation  of 
income  accounts  it  was  explained  that  the  income  accounts  are  to  be 
divided  into  two  main  groups.  These  two  groups  were  also  illustrated 
in  the  statement  of  profit  and  loss  shown  in  the  chapter  preceding 
this  one.  They  are:  (i)  operating  income  accounts;  (2)  non- 
operating  income  accounts,  or  "other"  income  accounts. 

It  was  explained. in  the  chapter  on  the  construction  and  inter- 
pretation of  expense  accounts,  and  illustrated  in  the  statement  of 
profit  and  loss  just  referred  to,  that  the  expense  accounts  are  also 
divided  into  two  main  groups,  as  follows:  (i)  operating  expense 
accounts;  (2)  non-operating  expense  accounts,  or  "deduction  from 
income"  accounts. 

The  operating  expenses  are  susceptible  of  very  elaborate  classifi- 
cation, where  the  size  and  complexity  of  the  business  enterprise 
justifies  it.  As  has  been  previously  suggested,  both  the  operating 
income  and  expense  accounts  may  be  classified  in  such  a  manner  as 
to  show  operating  income  and  operating  expense  for  each  department 
of  a  business,  and  also  to  show  a  classification  of  each  department's 
expenses  according  to  the  kind  of  services  rendered.  No  attempt  will 
be  made  to  show  any  such  elaborate  classification  in  this  chapter. 
The  classification  indicated  in  the  following  pages  will  be  for  the  busi- 
ness as  a  whole,  on  the  assumption  that  no  departmental  organization 
exists.  Where  departmental  organization  does  exist,  the  classification 
of  revenue  accounts  by  departments  may  extend  only  to  the  trading 
accounts,  so  that  it  is  possible  to  report  the  gross  profit  on  sales  by 


THE  CLASSIFICATION  OF  ACCOUNTS  341 

departments,  with  no  attempt  to  classify  other  operating  expenses  on  a 
departmental  basis.  On  the  other  hand,  a  systematic  attempt  may 
be  made  to  show  all  operating  expenses  classified  according  to  the 
departments  to  which  they  are  chargeable,  so  that  net  operating 
profit  may  be  reported  by  departments.  The  classification  of  accounts 
in  this  chapter  is  for  the  business  as  a  whole,  but  it  should  not  be 
difficult  for  the  student  to  see  how  a  similar  classification  of  accounts 
might  be  made  for  each  department  of  a  business,  the  extent  arid 
the  details  of  such  classification  being  modified  by  the  reporting 
requirements  of  the  particular  business  and  department. 

A  simple  classification  of  operating  expenses  according  to  the  type 
of  services  performed  is  as  follows:  (i)  cost  of  sales  accounts; 
(2)  buying  expense  accounts;  (3)  selling  expense  accounts;  (4)  deliv- 
ery expense  accounts;  (5)  administrative  expense  accounts. 

The  cost  of  sales  accounts,  which  furnish  the  information  neces- 
sary to  ascertain  the  cost  of  the  goods  sold,  are  not  usually  thought  of 
as  expense  accounts,  or  termed  expense  accounts  in  the  statement  of 
profit  and  loss.  They  do,  however,  represent  a  part  of  the  cost  of  the 
product  or  service  sold,  and  even  though  they  are  somewhat  different 
in  their  nature  from  the  other  operating  expense  accounts,  they  have 
enough  in  common  with  them  to  justify  including  them  under  expense 
in  the  present  classification. 

Each  of  the  classes  of  operating  expense  listed  above  has  been 
sufficiently  discussed  in  a  previous  chapter  to  make  further  con- 
sideration at  this  point  unnecessary. 

Illustration  of  the  revenue  accounts.    Taking  the  basis  of  classifi- 
cation previously  indicated,  and  assuming  a  mercantile  business  whose 
operations  are  not  to  be  classified  by  departments,  the  more  common 
and  representative  revenue  accounts  may  be  outlined  as  follows: 
III.  Revenue  accounts 
A.  Income  accounts 

1.  Operating  income 

o)  Merchandise  Sales 

(i)  Sales  Returns  and  Allowances 

2.  Non-operating  income 

a)  Interest  on  Notes  Receivable 

b)  Interest  on  Securities  Held 

c)  Rentals  Earned 

(f)  Cash  Discount  on  Purchases 


342  PRINCIPLES  OF  ACCOUNTING 

B.  Expense  accounts 

1.  Operating  expenses 

a)  Cost  of  Sales 

(1)  Merchandise  Purchases 

(a)  Purchases  Returns  and  Allowances 

(2)  Freight,  Express,  and  Cartage  Inward 

(Purchases   account  to  be  adjusted  for  the  change  in 
merchandise  inventory) 

b)  Buying  Expense 

(1)  Salaries  of  Buyers 

(2)  Traveling  Expense — Buyers 

(3)  Office  Expense 

(4)  Other  Buying  Expense 

c)  Selling  Expenses 

(1)  Salaries  of  Sales  Force 

(2)  Expenses  of  Salesmen 

(3)  Advertising 

(4)  Office  Expense 

(5)  Packing  and  Shipping  Expense 

(6)  Other  Selling  Expense 

d)  Delivery  Expenses 

(1)  Wages  of  Drivers 

(2)  Maintenance  and  Repairs — Delivery  Equipment 

(3)  Depreciation  of  Delivery  Equipment 

(4)  Other  Delivery  Expense 
«)  Administrative  Expense 

(1)  Office  Salaries 

(2)  Office  Expense 

(3)  Repairs  and  Maintenance  of  Buildings  (or  rent) 

(4)  Depreciation  of  Buildings 

(5)  Repairs  and  Maintenance  of  Equipment 

(6)  Depreciation  of  Office  Equipment 

(7)  Insurance  and  Taxes 

(8)  Heat  and  Light 

(9)  Other  Administrative  Expense 

2.  Non-operating  expenses 

a)  Interest  on  Notes  Payable 

b)  Cash  Discount  on  Sales 

This  list  of  revenue  accounts  is  by  no  means  exhaustive,  but  it 
shows  the  accounts  which  are  more  frequently  found  in  use.  The 
classification  is  not  an  exact  or  a  scientific  one,  such  as  would  be  used 


THE  CLASSIFICATION  OF  ACCOUNTS  343 

in  a  big  department  store  or  otKer  type  of  business  concern  where  it 
was  considered  worth  while  to  allocate  operating  expenses  carefully 
between  departments  and  between  kinds  of  expense  or  service 
rendered.  However,  the  discussion  of  accounts  and  their  use  up  to  this 
point  has  not  been  such  as  to  prepare  the  student  for  a  consideration 
of  any  more  elaborate  or  exact  classification  than  the  one  shown  above. 
The  principles  of  classification  are  well  illustrated  here,  and  the  con- 
sideration of  further  refinements  in  account  classification  must  be 
deferred  to  a  later  tune. 

Numbering  of  accounts.  In  any  business  possessing  a  well- 
developed  accounting  system,  some  definite  classification  of  accounts 
will  be  worked  out  and  maintained.  A  classification  along  the  lines 
indicated,  further  subdivided  to  show  departmental  organization  or 
further  division  of  functions  in  the  business,  would  be  an  entirely 
satisfactory  one.  In  this  classification,  however,  no  adequate  method 
is  provided  for  referring  to  the  individual  accounts,  since  the  same 
letters  and  figures  are  used  to  indicate  different  items  under  various 
heads  and  subheads.  Also,  with  the  system  employed  to  list  the 
accounts,  the  addition  of  a  new  item  or  class  of  items  might  involve 
some  difficulty  in  a  rearrangement  of  the  numbering.  In  order  to 
facilitate  the  classification  of  accounts,  and  the  reference  to  particular 
accounts  in  a  system,  accountants  have  adopted  a  system  of  number- 
ing accounts  which  is  a  modification  of  the  Dewey  decimal  system 
used  hi  cataloguing  the  contents  of  a  library.  Under  this  system 
each  account  has  a  separate  number,  which  is  usually  written  before 
the  descriptive  name  of  the  account,  and  which  serves  to  place  the 
class  to  which  that  account  belongs.  This  number  may  even  be  used 
instead  of  the  descriptive  name  hi  referring  to  the  account. 

The  use  of  this  system  may  be  best  explained  by  a  description 
and  illustration  of  the  method  of  its  application,  using  the  same 
classification  of  accounts  that  was  given  above.  In  that  classification, 
the  three  main  groups  into  which  all  accounts  were  divided  were 
property  accounts,  proprietorship  accounts,  and  revenue  accounts. 
These  primary  classes  will  each  be  given  a  number  consisting  of  a 
single  digit,  thus: 

1.  Property  accounts 

2.  Proprietorship  accounts 

3.  Revenue  accounts 


344  PRINCIPLES  OF  ACCOUNTING 

Every  account  which  falls  under  the  head  of  property  accounts  will 
therefore  have  a  number  the  first  digit  of  which  is  i,  every  proprie- 
torship account  will  have  a  number  the  first  digit  of  which  is  2, 
and  every  revenue  account  will  have  number  in  which  3  is  the  first 
digit.  For  example,  the  two  main  classes  into  which  the  property 
accounts  are  divided  will  be  numbered  as  follows: 

11.  Asset  accounts 

12.  Liability  accounts 

Every  account  which  is  classified  under  the  asset  group  will  therefore 
have  a  number  of  which  the  first  two  digits  are  n,  and  in  the  same 
way  the  first  two  digits  of  any  number  indicating  a  liability  account 
will  be  12.  The  same  procedure  is  followed  with  all  the  subclasses  of 
accounts.  Where  it  is  necessary  to  show  a  "valuation"  account,  or 
account  representing  a  deduction  from  another  item,  it  is  listed  just 
below  the  item  from  which  it  is  to  be  deducted,  and  its  nature  is 
indicated  by  introducing  zero  before  the  last  digit,  the  digits  used 
being  otherwise  the  same  as  those  used  for  the  account  from  which 
the  deduction  is  to  be  made. 

Illustration  of  the  numbering  of  accounts.  With  this  brief  expla- 
nation in  mind,  it  should  not  be  difficult  to  understand  the  principles 
of  this  system  as  applied  to  the  classification  of  accounts  previously 
given.  In  illustrating  this,  it  will  be  assumed  that  the  proprietorship 
accounts  are  those  of  a  corporation.  The  illustration  follows: 

i.  Property  accounts 
ii.  Asset  accounts 
in.  Current  assets 
mi.     Cash 
in 2.    Notes  Receivable 

1 1 102.  Notes  Receivable  Discounted 

1113.  Accounts  Receivable 

11103.  Reserve  for  Bad  Debts 

1 1 14.  Merchandise  Inventory 

1115.  Accrued  Interest  Receivable 
112.  Deferred  charges 

1 121.  Prepaid  Advertising 
1 1 2  2.  Unexpired  Insurance 
1123.  Inventory  of  Current  Supplies 


THE  CLASSIFICATION  OF  ACCOUNTS  345 

113.  Fixed  assets 

1131.  Store  Equipment 

11301.  Reserve  for  Depreciation  of  Store  Equipment 

1132.  Delivery  Equipment 

11302.  Reserve  for  Depreciation  of  Delivery  Equipment 

1133.  Office  Equipment 

11303.  Reserve  for  Depreciation  of  Office  Equipment 

1134.  Buildings 

11304.  Reserve  for  Depreciation  of 'Buildings 

1135.  Land 
12.  Liability  accounts 

121.  Current  liabilities 

1 2 1 1 .  Notes  Payable — B  anks 

1212.  Notes  Payable — Trade  Creditors 

1213.  Accounts  Payable 

1214.  Accrued  Wages 

1215.  Accrued  Interest  Payable 

122.  Fixed  liabilities 

1 22 1.  Notes  Payable  (not  current) 

1222.  Mortgages  Payable 

1223.  Bonds  Payable 
Proprietorship  accounts 

21.  Capital  stock 

211.  Common  Capital  Stock 

2101.  Discount  on  Common  Stock 

212.  Preferred  Capital  Stock 

2102.  Discount  on  Preferred  Stock 

22.  Reserves 

221.  Reserve  for  Addition  to  Plant 

222.  Sinking  Fund  Reserve 

223.  Reserve  for  Redemption  of  Bonds 

23.  Capital  Surplus 

24.  Surplus 
Revenue  accounts 
31.  Income  accounts 

311.  Operating  income 

3111.    Merchandise  Sales 

31101.  Sales  Returns  and  Allowances 

312.  Non-operating  income 

3121.  Interest  on  Notes  Receivable 

3122.  Interest  on  Securities  Held 

3123.  Rentals  Earned 

3124.  Cash  Discount  on  Purchases 


PRINCIPLES  OF  ACCOUNTING 

32.  Expense  accounts 

321.  Operating  expenses 

3211.  Cost  of  Sales 

32111.  Merchandise  Purchases 
321101.  Purchase  Returns  and  Allowances 

32112.  Freight,  Express,  and  Cartage  Inward 

3212.  Buying  Expense 

32121.  Salaries  of  Buyers 

32122.  Traveling  Expense — Buyers 

32123.  Office  Expense 

3  2 1 24.    Other  Buying  Expense 

3213.  Selling  Expense 

32131.  Salaries  of  Sales  Force 

32132.  Expenses  of  Salesmen 

32133.  Advertising 

32134.  Office  Expense 

32135.  Packing  and  Shipping  Expense 

32136.  Other  Selling  Expense 

3214.  Delivery  Expense 

32141.  Wages  of  Drivers 

32142.  Maintenance  and  Repairs — Delivery  Equipment 

32143.  Depreciation  and  Delivery  Equipment 

32144.  Other  Delivery  Expense 

3215.  Administrative  Expense 

32151.  Office  Salaries 

32152.  Office  Expense 

32153.  Repairs  and  Maintenance  of  Buildings 

32154.  Depreciation  of  Buildings 

32155.  Insurance  and  Taxes 

32156.  Heat  and  Light 

32157.  Other  Administrative  Expense 

322.  Non-operating  expenses 

3221.  Interest  on  Notes  Payable 

3222.  Cash  Discount  on  Sales 

3223.  Exchange 

Lack  of  uniformity  in  classification  and  numbering  of  accounts 
This  scheme  of  numbering  is  a  simple  one  and  is  easily  applicable  to  the 
numbering  of  accounts  in  a  business  as  simple  in  organization  as  the 
one  assumed  for  purposes  of  illustration.  A  more  elaborate  classifi- 
cation of  accounts  would  soon  cause  the  numbering  to  become 
awkward  and  cumbersome,  on  account  of  the  number  of  digits 


THE  CLASSIFICATION  OF  ACCOUNTS  347 

involved.    It  is  quite  possible,  however,  to  modify  the  numbering 
system  to  handle  a  more  complex  classification  without  confusion. 

An  example  of  such  a  classification  is  to  be  found  in  the  uniform 
classification  of  accounts  prescribed  by  the  Interstate  Commerce 
Commission  for  the  steam  railroad  companies  which  fall  under  the 
regulation  of  that  body. 

The  fundamental  classification  of  accounts  given  in  this  chapter 
is  a  threefold  one,  dividing  account  into:  ""(i)  property  accounts, 
(2)  proprietorship  accounts,  and  (3)  revenue  account.  The  difference 
between  this  threefold  classification  and  a  twofold  classification  oT* 
accounts  into  real  and  nominal  accounts  is  largely  one  of  terminology 
rather  than  of  basic  principles.  There  is,  however,  a  real  difference 
hi  principle  involved  in  the  fact  that  the  threefold  classification 
recognizes  that  the  "real"  or  balance-sheet  accounts  fall  hi  to  two  main 
classes,  each  of  which  is  co-ordinate  in  importance  with  the  "nominal," 
"  economic,"  or  "  revenue  "  group  of  accounts.  Aside  from  this  point, 
the  classification  given  here  differs  very  little  in  purpose  and  result 
from  the  classifications  given  by  John  R.  Wildman,  Roy  B.  Kester, 
Thomas  W.  Mitchell,  and  other  well-known  modern  writers  on  the 
subject  of  accounting. 

QUESTIONS  FOR  CLASS  DISCUSSION 

1.  What  real  distinction,  if  any,  is  to  be  made  between  a  classification 
of  accounts  into  "real"  accounts  and  "nominal"  accounts,  and  their 
classification  into  "property"  accounts,   "proprietorship"  accounts, 
and  "revenue"  accounts?    Is  either  basis  of  classification  more  logical 
than  the  other  ?    Discuss. 

2.  Make  as  long  a  list  as  you  can  of  factors  which  might  affect  the  classi- 
fication of  the  accounts  of  any  business. 

3.  The  Gross  Shoe  Company  has  retail  stores  in  five  different  cities.    In 
each  they  own  the  building  in  which  they  operate,  as  well  as  all  the 
equipment  used  in  carrying  on  the  business.    The  home  office  is  in 
Chicago,  but  each  store  is  in  charge  of  a  local  manager.    The  merchan- 
dise is  all  purchased  by  the  central  organization,  and  supplied  by  it  to 
the  various  branches.    Do  these  facts  suggest  to  you  the  desirability 
of  any  further  sub-classification  of  the  accounts  than  is  shown  in  the 
illustrations  in  chapter  xxix?    Answer  this  question  with  regard  to: 
(i)  the  asset  accounts,  (2)  the  liability  accounts,  (3)  the  proprietorship 
accounts,  (4)  the  income  accounts,  (5)  the  expense  accounts. 


348  PRINCIPLES  OF  ACCOUNTING 

4.  What  groups  of  accounts,  if  any,  would  need  to  be  rearranged  or  classi- 
fied in  more  detail  than  that  shown  in  chapter  xxix  to  serve  the  report- 
ing requirements  of  a  department  store  ?    a  manufacturing  business  ? 

5.  In  the  illustrative  classification  given  in  chapter  xxix,  the  operating 
expense  accounts  are  divided  into  five  groups.     Can  you  suggest  any 
further  division  that  might  be  made  of  the  operating  expenses  of  a 
business?    What   purpose   might    be   served   by   a   more   elaborate 
classification  of  operating  expenses  according  to  the  type  of  service 
performed  ? 

6.  Various  members  of  the  managerial  staff  of  a  large  department  store 
require  analyses  of  sales  for  different  purposes.     In  order  to  satisfy 
these  various  requirements,  the  accounting  department  must  prepare 
a  sales  analysis  on  each  of  the  following  bases: 

a)  Sales  analyzed  by  departments 
6)  Sales  analyzed  by  terms  of  sale 

c)  Sales  analyzed  by  method  of  sale 

d)  Sales  analyzed  by  method  of  delivery 

e)  Sales  analyzed  as  between  rush  and  normal  deliveries 
/)  Sales  analyzed  by  salesmen 

What  purpose  should  you  expect  to  be  served  by  each  of  the  foregoing 
analyses?  What  member  of  the  managerial  staff  would  be  apt  to  be 
interested  in  each  ? 

7.  Should  you  consider  it  necessary  or  desirable  to  provide  an  analysis 
of  purchases  on  each   of   the  foregoing   bases?  on  any  of   them? 
On  how  many  of  these  bases  should  sales  deductions  be  analyzed? 
Discuss. 

8.  Should  you  consider  it  desirable  to  attempt  to  maintain  in  the  ledger 
accounts  all  the  classifications  suggested  in  Question  6  ?    If  not,  which 
ones  should  you  maintain  in  the  accounts?    Suggest  the  means  by 
which  each  of  the  classifications  not  provided  by  the  ledger  accounts 
might  be  made  available. 

REFERENCES  FOR  FURTHER  STUDY 
WILDMAN,  J.  R.,  Principles  of  Accounting,  chap,  xi,  pp.  128-29. 
DICKINSON,  A.  L.,  Practice  and  Procedure,  pp.  36,  56-62,  154,  162. 
PATON,  W.  A.,  AND  STEVENSON,  R.  A.,  Principles  of  Accounting,  chaps. 

vi  and  vii. 
ESQUERRE,  PAUL- JOSEPH,  Applied  Theory  of  Accounts,  chap.  xii. 


CHAPTER  XXX 

FINANCIAL  REPORTS 

Nature  and  purpose  of  financial  reports.  It  has  been  repeatedly 
stated  in  the  preceding  chapters  that  the  end  and  aim  of  the  account- 
ing process  is  furnishing  information  for  reports  which  will  be  of  aid 
in  the  conduct  of  the  business.  It  is  the  purpose  of  this  chapter  to 
consider  somewhat  more  carefully  the  method  of  presentation  to  be 
employed  when  the  necessary  data  are  available.  The  reports  which 
may  be  prepared  from  the  accounts  are  all  of  a  financial  nature; 
that  is  to  say,  they  deal  with  facts  about  the  business  which  may  be 
expressed  in  terms  of  dollars  and  cents.  They  may  therefore  be 
properly  referred  to  as  financial  reports.  It  is  quite  likely,  as  has  been 
suggested,  that  in  many  businesses  statistical  data  will  be  gathered 
by  means  of  supplementary  records  having  no  direct  connection  with 
the  accounting  system  proper.  Some  of  this  information  may  be  of  a 
financial  nature,  and  some  of  it  may  be  in  terms  of  non-financial  units. 
An  illustration  of  such  statistics  is  furnished  by  the  operating  statistics 
of  a  railroad,  which  show  among  other  things  the  number  of  "ton- 
miles"  of  freight  hauled  during  an  operating  period,  and  the  number 
of.  "passenger-miles"  as  well.  A  manufacturing  company  may  keep 
records  of  production  of  individual  workmen  and  individual  machines 
in  terms  of  units  of  product.  A  department  store  may  keep  records 
concerning  deliveries  of  goods  from  its  departments  and  to  different 
sections  of  the  territory  it  serves,  these  facts  being  expressed  in 
non-financial  terms.  The  discussion  of  ribn-financial  statistics  and 
reports,  however,  which  may  be  as  important  in  their  way  as  the 
financial  ones,  cannot  be  given  a  place  in  this  text. 

This  chapter  will  be  devoted  to  the  more  generally  used  forms  of 
financial  reports  (more  or  less  conventional  in  their  form)  prepared 
from  the  information  furnished  by  the  ledger  accounts.  This  will 
involve  the  explanation  of  some  modifications  of  methods  of  presenta- 
tion already  shown,  and  the  introduction  of  certain  additional  reports. 

The  conventional  financial  reports.  Throughout  the  discussion 
of  accounting  reports  in  the  earlier  chapters,  two  forms  of  report,  the 

349 


PRINCIPLES  OF  ACCOUNTING 

balance  sheet  and  the  statement  of  profit  and  loss,  have  been  used  as 
typical  of  all  such  reports.  Accountants  and  business  men  formerly 
thought  that  these  were  the  only  reports  necessary.  In  fact,  in  many 
cases  they  failed  to  realize  that  it  was  possible  to  prepare  any  other 
reports  from  the  information  furnished  by  the  accounts  of  the  business. 
In  recent  years,  however,  as  business  problems  have  become  more 
complex,  and  as  a  higher  grade  of  managerial  skill  has  developed  to 
meet  these  problems,  managers  have  come  to  realize  the  need  of 
information  in  addition  to  that  furnished  by  these  two  conventional 
statements. 

The  attempt  which  accountants  have  made  to  furnish  such 
information  has  taken  two  forms:  (i)  the  modification,  rearrangement, 
and  improvement  of  the  conventional  accounting  reports;  (2)  the 
preparation  of  additional  accounting  and  statistical  reports:  (a)  re- 
ports showing  the  results  of  business  operations  in  the  period  or 
periods  past,  (b)  estimates  of  various  phases  of  future  operations, 
based  on  the  records  of  past  operations  and  designed  to  aid  the 
management  in  planning  for  the  future. 

Any  consideration  of  the  subject  of  estimates  must  be  omitted  from 
this  text,  though  it  constitutes  a  very  important  part  of  accounting 
for  managerial  purposes.  Some  consideration  will  be  given,  however, 
to  the  modern  forms  of  the  conventional  accounting  reports,  and  to 
certain  additional  reports  which  are  now  in  wide  use. 

Exhibits.  The  reports  prepared  by  the  accountant  which  set 
forth  the  basic  facts  of  the  financial  condition  of  a  business  are  usually 
termed  exhibits.  An  exhibit,  in  accounting,  may  be  defined  as  a 
summarized  statement  of  facts  with  regard  to  the  financial  condition 
of  a  business.  The  exhibits  which  are  usually  prepared  by  the 
accountant  are  three  in  number,  and  are  as  follows:  (i)  the  balance 
sheet,  generally  designated  as  "Exhibit  A";  (2)  the  statement  of 
profit  and  loss,  generally  designated  as  "Exhibit  B";  (3)  an  analysis 
of  the  surplus  account,  generally  designated  as  "Exhibit  C." 

The  present  tendency  in  the  preparation  of  these  fundamental 
reports  is  to  condense  the  information  shown  by  them  to  such  an 
extent  as  to  free  it  from  a  great  deal  of  detail,  thereby  making  it  more 
readily  readable.  Such  a  statement  is  designed  to  present  almost  at  a 
glance  the  salient  facts  concerning  that  particular  phase  of  the  finan- 
cial condition  or  operations  of  the  business.  The  exhibits  are  intended 


FINANCIAL  REPORTS  351 

to  present  to  the  manager,  owner,  or  other  interested  party  a  "bird's- 
eye  view"  of  the  financial  condition  of  the  business.  This  does  not 
mean  that  the  reader  is  to  be  left  in  the  dark  with  regard  to  the 
individual  items  which  make  up  the  more  important  totals  shown  by 
these  reports.  This  detailed  information  is  presented  in  separate 
statements,  accompanying  and  supporting  the  exhibits.  These 
supplementary  statements  are  discussed  below. 

Schedules.  The  supplementary  statements  which  furnish  infor- 
mation with  respect  to  detail  composing  the  more  important  items 
shown  in  the  exhibits  are  known  as  schedules.  A  schedule,  in  this 
sense,  is  a  detailed  list  of  the  individual  items  composing  the  total  of 
some  item  which  appears  in  an  accounting  report.  Thus  schedules 
may  be  prepared  in  connection  with  the  balance  sheet.  They  are 
designated  numerically,  as  "Schedule  No.  i,"  "Schedule  No.  2,"  etc. 
Schedules  may  be  used  to  show  detail  with  regard  to  the  cash  balance, 
the  notes  receivable  and  payable,  the  accounts  receivable  and  payable, 
the  buildings  or  equipment  owned  by  the  business,  the  reserve  for 
depreciation  maintained  for  each,  the  securities  owned,  or  any  other 
item  on  the  balance  sheet  which  may  be  of  sufficient  importance. 
When  any  item  on  the  balance  sheet  is  supported  by  a  schedule  it  is 
customary  to  indicate  that  fact  by  giving  a  reference  to  the  schedule 
in  connection  with  the  statement  of  the  item  on  the  exhibit.  Thus, 
taking  for  illustration  the  item  of  "Cash,"  which  would  ordinarily 
appear  first  on  the  balance  sheet,  this  item  would  be  shown  in  the 
balance  sheet  as  a  single  item,  as  follows: 

Cash  (Schedule  No.  i) $22,350.00 

SCHEDULE  NO.  1 
THE  CASH  BALANCE 

Continental  and  Commercial  Bank       .       .  $  8,250.00 

Illinois  Trust  and  Savings  Company    .       .  13,300.00 

Home  Office  Cash  Fund 300.00 

Milwaukee  Branch  Office  Cash  Fund   .       .  500.00 


Total $22,350.00 

Each  item  on  the  balance  sheet  which  represents  a  combination  of 
several  items,  and  which  is  considered  sufficiently  important  to  justify 
a  detailed  report  as  to  its  component  items,  is  supported  by  some  such 
schedule. 


352  PRINCIPLES  OF  ACCOUNTING 

Analytical  statements.  The  statement  of  profit  and  loss  will  also 
contain  certain  items  which  represent  a  condensation  of  more  detailed 
information  furnished  by  the  accounts.  In  order  to  make  available 
a  knowledge  of  the  detail  composing  such  items,  supplementary 
statements  are  necessary  here  also,  as  in  the  case  of  the  balance  sheet 
items.  A  number  of  accountants  make  no  differentiation  between 
the  nature  of  such  statements  and  that  of  the  schedules  prepared  in 
support  of  the  balance  sheet  items,  calling  them  all  "schedules." 
But  the  analysis  of  some  class  of  income  or  of  expense  seems  to  differ 
somewhat  in  its  nature  from  the  mere  listing  of  the  assets  or  the 
liabilities  which  make  up  a  certain  group  total  as  shown  on  the  balance 
sheet.  For  this  reason  many  accountants  make  it  a  practice  to  differ- 
entiate between  the  type  of  supplementary  statement  which  shows  an 
analysis  (called  an  analytical  statement)  and  the  type  which  is  merely 
a  list  of  certain  items  composing  a  total.  Such  analytical  statements 
are  typically  presented  in  connection  with  items  appearing  in  the 
statement  of  profit  and  loss.  "Buying  expense"  may  be  used  to 
illustrate  the  analytical  statement.  On  the  statement  of  profit  and 
loss,  in  order  to  avoid  making  this  statement  too  long  and  compli- 
cated, the  buying  expenses  would  be  summarized  as  follows: 

Buying  expense  (Analytical  Statement  No.  i)     .       .       $5,300.00 

Analytical  Statement  No.  i,  which  will  accompany  the  statement 
of  profit  and  loss,  will  appear  as  follows: 

ANALYTICAL  STATEMENT  NO.  1 
ANALYSIS  OF  BUYING  EXPENSE 

Salaries  of  buyers $3,600.00 

Traveling  expenses  of  buyers         .       .       .         1,200.00 

Office  expense — buying 300.00 

Miscellaneous  buying  expense        .       .       .  150.00 

Total  buying  expense       ....       $5,300.00 

Similar  statements  would  be  prepared  for  each  important  group 
of  expenses  and  in  some  cases  for  operating  income.  As  already 
explained,  these  supplementary  statements  are  sometimes  called 
schedules  and  treated  as  a  continuation  of  the  series  of  schedules 
begun  in  connection  with  the  balance  sheet.  However,  the  differ- 
entiation adopted  and  illustrated  above  is  a  logical  one,  and  represents 
acceptable  accounting  practice. 


FINANCIAL  REPORTS  353 

The  comparative  balance  sheet.  The  form  of  "  exhibit ' '  to  which  the 
most  attention  is  usually  given  is  the  balance  sheet.  The  information 
furnished  by  such  a  statement  is  very  important,  showing  as  it  does 
the  status  of  the  business  investment  at  the  end  of  the  operating 
period.  It  may  be  even  more  significant  if  the  statement  furnishes 
a  basis  for  comparing  the  facts  revealed  by  the  balance  sheet  at  the 
end  of  the  current  period  with  the  facts  shown  by  the  balance  sheet 
at  the  end  of  the  preceding  period.  Such  a  comparison  may  even  be 
profitably  extended  over  several  previous  periods.  Such  a  basis  of 
comparison  is  furnished  by  the  comparative  balance  sheet,  an 
illustration  of  which  is  presented  on  page  354. 

None  of  the  changes  which  may  be  noted  as  taking  place  in  the 
various  items  of  this  statement  between  the  end  of  the  preceding 
period  and  the  end  of  the  current  period  appears  at  all  startling. 
Some  of  the  changes,  however,  will  be  seen  to  be  rather  significant 
with  regard  to  the  company's  financial  policy  for  the  year.  The 
first  thing  to  be  noted  is  the  change  in  the  company's  net  proprietor- 
ship. A  glance  at  that  section  of  the  comparative  balance  sheet  shows 
that  the  total  proprietorship  as  shown  by  that  group  of  accounts  has 
increased  from  $193,835  to  $222,345,  a  net  increase  of  $28,510.  This 
would  seem  at  first"  glance  to  indicate  that  this  figure  represented  the 
amount  of  the  company's  net  income  for  the  year.  This  would  be 
true,  provided  there  had  been  no  contributions  made  to  capital  during 
the  year,  and  that  no  distribution  of  surplus  had  been  made  in  the 
form  of  dividends  or  otherwise.  As  a  matter  of  fact,  the  situation  is 
seldom  so  simple.  In  order  to  understand  the  changes  that  have  taken 
place  in  the  various  proprietorship  accounts,  the  comparative  balance 
sheet  must  be  supplemented  by  another  statement,  accounting  for 
these  changes. 

The  analysis  of  the  surplus  account.  This  form  of  statement  was 
mentioned  in  a  previous  paragraph  as  one  of  the  three  chief  financial 
statements  usually  prepared  at  the  end  of  a  fiscal  period,  and  is 
usually  designated  as  "Exhibit  C."  It  is  designed  to  show  the 
analysis  of  the  debits  and  credits  which  have  been  made  to  the  general 
surplus  account,  and  so  to  account  for  the  changes  that  may  have 
taken  place  in  the  balance  of  this  account  and  the  balances  of  the 
proprietary  reserve  accounts,  which  represent  appropriated  surplus. 


354 


PRINCIPLES  OF  ACCOUNTING 


TAYLOR,  JOHNSON  AND  COMPANY 
COMPARATIVE  BALANCE  SHEET,  DECEMBER  31 


Assets 

1919 

1920 

Current  A  ssets 
Cash  

43,150 
400 

00 
00 

20,600 
22,400 

42,750 

52,800 
35 

00 

oo 
oo 

oo 
oo 

50,200 

500 

13.900 

5.700 

00 

oo 
oo 

00 

22.3SC 

26,8oc 

49,700 

45,500 
135 

oo 

;c 

00 

oo 
oo 

Accounts  Receivable  

Less  Reserve  for  Bad  Debts  

12,800 
3,100 

oo 

00 

Accrued  Interest  Receivable  

Total  current  assets  

138,585 

oo 

144,485 

oo 

Fixed  Assets 
Delivery  Equipment  

9,700 

12,700 
3,750 

104,000 
40,000 

00 

oo 
oo 

00 

oo 

8,200 

II.IOO 

3,000 

106,600 
40,000 

00 

oo 
oo 

oo 
oo 

Less  Reserve  for  Depreciation  
Store  Equipment  

15,50° 
2,800 
4,5oo 
750 

oo 
oo 
oo 

oo 

15,500 
4,400 
4,800 
1,710 

oo 
oo 
oo 
oo 

Less  Reserve  for  Depreciation  

Less  Reserve  for  Depreciation  
Building  

115.000 
11,000 

oo 
oo 

120,000 

13,400 

oo 

00 

Less  Reserve  for  Depreciation 

Land  

Total  fixed  assets  

170,150 

oo 

168,990 

00 

Total  assets  

308,735 

oo 

313.475 

oo 

Liabilities 

1919 

1920 

Current  Liabilities 
Due  to  Contractor  

2,000 
150 
250 
20,500 
13,000 
19,000 

oo 
oo 
oo 

00 

oo 
oo 

6,710 

120 

300 

18,500 
7,500 

18,000 

oo 
oo 
oo 
oo 
oo 
oo 

Wages  Accrued  

Notes  Payable  —  Banks  

Notes  Payable  —  Trade  Creditors  
Accounts  Payable  

Total  current  liabilities  

54,900 

oo 

51,130 

oo 

Fixed  Liabilities 
Bonds  Payable  

50,000 

oo 

40,000 

oo 

Total  liabilities  

164,900 

oo 

91,130 

oo 

Proprietorship 

1919 

1920 

Common  Capital  Stock  

100,000 

50,000 

12,000 
10,500 

31,335 

00 

oo 
oo 
oo 
oo 

100,000 

50,000 
12,500 
5,500 
54,345 

oo 
oo 
oo 
oo 
oo 

--Preferred  Capital  Stock  

Reserve  for  Redemption  of  Bonds  .... 
Reserve  for  Addition  to  Building  
Surplus  

203,835 

oo 

222,345 

oo 

Total  liabilities  and  proprietorship 

308.735 

oo 

313,475 

00 

FINANCIAL  REPORTS 


355 


In  the  case  of  Taylor,  Johnson  and  Company  the  changes  which 
affected  these  accounts  were  as  follows: 

1.  January  3,  1920,  dividends  of  2\  per  cent  on  the  common  stock,  and 
$\  per  cent  on  the  preferred  stock,  were  declared  and  paid. 

2.  July  6,  1920,  another  dividend  of  the  same  amount  as  the  above  was 
declared  and  paid  on  both  common  and  preferred  stock. 

3.  January  3,  1920,  it  was  voted  to  appropriate  $10,500  more  as  an 
addition  to  the  reserve  for  redemption  of  bonds. 

4.  July  2,  1920,  $10,000  of  the  company's  bonded  indebtedness  was 
retired.    This  amount  was  transferred  from  the  reserve  account  back  to  the 
general  surplus  account. 

5.  November  12,  1920,  an  improvement  to  the  building,  costing  $5,000 
was  completed  and  paid  for.    That  amount  was  transferred  from  the 
account  with  reserve  for  addition  to  building  back  to  the  general  surplus 
account. 

6.  Net  income  for  the  year,  as  shown  by  statement  of  profit  and  loss, 
was  $27,010. 

The  proprietorship  accounts  affected  by  these  changes,  as  they 
would  appear  at  the  end  of  the  year  after  the  appropriate  entries  had 
been  made  and  posted,  are  shown  below: 

SURPLUS 


1920 

1920 

Jan.     3 

Dividends 

4,250 

00 

Jan.     i 

Balance 

31,335 

oo 

Jan.     3 

Reserve      for      re- 

July    2 

Reserve     for     re- 

demption of  bonds 

10,500 

00 

demption  of  bonds 

10,000 

oo 

July     6 

Dividends 

4,250 

oo 

Nov.  12 

Reserve    for    addi- 

tion to  building 

5,000 

oo 

Dec.  31 

Profit  and  loss 

27,010 

oo 

RESERVE  FOR  REDEMPTION  OF  BONDS 


1920 

1920 

July     2 

Surplus 

10,000 

00 

Jan.     i 

Balance 

12,000 

00 

Jan.     3 

Surplus 

10,500 

00 

RESERVE  FOR  ADDITION  TO  BUILDING 


1920 
Nov.  12 

Surplus 

5,ooo 

oo 

1920 
Jan.     i 

Balance 

10,500 

00 

In  this  case  the  statement  showing  the  analysis  of  the  surplus 
account  would  appear  as  follows: 


356 


PRINCIPLES  OF  ACCOUNTING 


TAYLOR,  JOHNSON  AND  COMPANY 
ANALYSIS  OF  SURPLUS  ACCOUNT  FOR  THE  YEAR  ENDED  DECEMBER  21,  1920 

Balance,  January  i $3i,335-oo 

Add: 

Reserve  for  redemption  of  bonds 
utilized  and  transferred  back  to 

surplus $10,000.00 

Reserve  for  addition  to  building 
utilized  and  transferred  back  to 

surplus 5,000.00 

Net  income  for  fiscal  year       .       .       27,010.00        42,010.00 

Total $73,345-0° 

Deduct: 

Appropriated  for  dividends     .       .         8,500.00 
Appropriated  to  reserve  for  redemp- 
tion of  bonds         ....       10,500.00        19,000.00 

Balance,  December  31,  1920 $54,345.00 

With  the  information  furnished  by  the  comparative  balance 
sheet,  supplemented  by  that  furnished  by  the  analysis  of  surplus 
account,  it  is  possible  to  draw  some  fairly  definite  conclusions  with 
regard  to  the  financial  policy  of  the  company  during  the  year  1920. 
It  may  be  noted  first  that  the  net  income  of  $27,010  represents  a 
return  of  about  12  per  cent  on  the  net  investment  at  the  end  of  the 
year,  a  satisfactory  rate  of  return.  It  will  be  noted  next  that  the 
total  of  the  current  assets  has  increased  from  $138,585  to  $144,485, 
a  change  of  $5,900.  This  is  a  comparatively  insignificant  increase, 
but  it  is  to  be  noted  at  the  same  time  that  the  total  of  the  current 
liabilities  has  decreased  from  $54,900  to  $51,130.  This  means  that 
the  "working  capital,"  which  is  the  difference  between  the  current 
assets  and  current  liabilities,  has  increased  from  $83,685  to  $93,355, 
an  increase  of  $9,670,  or  more  than  u  per  cent.  It  also  means  that 
the  ratio  of  the  current  assets  to  the  current  liabilities  has  changed 
from  a  little  more  than  two  to  one  to  a  little  less  than  three  to  one. 
Since  two  to  one  is  the  ratio  usually  considered  by  the  banks  as  safe, 
it  is  apparent  that  the  present  ratio  is  a  satisfactory  one.  An  exami- 
nation of  the  current  assets  and  current  liabilities  in  detail  furnishes 
some  further  indications  with  regard  to  the  trend  of  the  company's 


FINANCIAL  REPORTS  357 

financial  policy.  Thus  it  appears  that  the  merchandise  inventory 
has  been  reduced  by  $7,30x3,  while  at  the  same  time  cash,  notes 
receivable,  and  accounts  receivable  have  increased  hi  amount.  This 
would  seem  to  indicate  that  the  company  was  reducing  its  inventory 
in  the  expectation  of  a  period  of  falling  prices  at  the  same  time  that 
they  were  selling  more  than  in  the  previous  year,  if  the  trade  receiv- 
ables are  to  be  taken  as  a  guide.  This  seems  to  indicate  that  they  are 
liquidating  their  current  assets  as  far  as  is  consistent  with  successful 
operation,  either  to  be  prepared  for  a  contraction  of  credits  by  the 
banks  or  to  take  advantage  of  the  expected  fall  in  merchandise  prices, 
if  not  for  both  reasons.  The  considerable  reduction  that  has  been 
effected  in  the  current  liabilities  seems  to  point  to  the  same  conclusion. 

An  examination  of  the  fixed  assets  seems  to  indicate  that  the 
normal  rate  of  depreciation  has  been  charged  off.  An  addition  of 
$1,100  to  the  amount  of  delivery  equipment  would  seem  to  indicate 
that  an  increased  volume  of  sales  had  caused  the  need  of  additional 
equipment  of  this  type.  This  surmise  can  be  verified  only  by  refer- 
ence to  the  comparative  statement  of  profit  and  loss,  which  appears 
on  a  later  page.  A  slight  increase  in  office  equipment  also  appears, 
which  would  seem  to  indicate  some  increase  in  the  volume  of  business. 
A  $5,000  item  of  addition  or  improvement  to  the  building  also  points 
to  a  progressive  policy  on  the  part  of  the  company. 

The  redemption  of  $10,000  of  the  outstanding  bonds  of  the  com- 
pany, together  with  the  further  appropriation  of  surplus  for  the 
redemption  of  bonds,  seems  to  indicate  that  the  company  is  following 
the  policy  of  retiring  its  bonds  in  yearly  instalments,  either  by  pur- 
chasing them  on  the  open  market  or  by  calling  them  in  accordance  with 
the  terms  of  the  contract  with  the  bondholders,  or  by  paying  them 
serially,  as  they  mature.  Thus  the  bonds  might  have  been  issued 
with  different  maturities,  so  that  the  $10,000  would  mature  each  year 
until  they  had  all  been  redeemed. 

The  amount  of  the  proprietorship  in  relation  to  the  amount  of 
assets  seems  very  large,  and  indicates  that  the  business  has  been  quite 
prosperous.  It  also  indicates  that  the  company  is  in  excellent  finan- 
cial condition,  and  should  be  in  no  great  danger  of  embarrassment 
from  falling  prices  or  from  financial  stringency.  For  that  matter, 
the  showing  made  by  their  comparative  balance  sheet  should  entitle 
them  to  preferential  treatment  in  applying  to  the  banks  for  credit. 


358  PRINCIPLES  OF  ACCOUNTING 

One  of  the  important  uses  of  such  a  statement  is  to  serve  as  an  aid  to 
the  business  in  securing  credit  from  the  banks,  since  it  furnishes  the 
banker  with  just  the  type  of  information  that  he  requires  with  ref- 
erence to  the  financial  soundness  of  the  borrowing  concern.  Also 
this  form  of  report,  with  the  analysis  of  surplus  account  and  the  com- 
parative statement  of  profit  and  loss,  furnishes  information  of  very 
great  value  to  the  owners  or  managers  of  the  business,  enabling  them 
to  judge  the  success  of  the  operations  of  the  current  period,  and 
also,  in  the  light  of  the  knowledge  thus  acquired,  to  plan  for  the 
operations  of  the  coming  period. 

The  comparative  statement  of  profit  and  loss.  It  has  been  demon- 
strated that  there  are  certain  advantages  in  presenting  the  balance 
sheet  in  the  comparative  form.  Any  statistical  data,  in  order  to  be  of 
the  highest  significance,  must  be  presented  in  such  a  way  as  to  show 
comparison  or  relationship  between  facts.  This  applies  to  the  facts 
shown  by  the  balance  sheet,  and  it  applies  even  more  to  the  statistics 
regarding  the  operations  of  the  business,  shown  by  the  statement  of 
profit  and  loss.  This  statement  is  supposed  to  present  the  leading 
statistical  facts  with  regard  to  the  period's  operations,  and  so  to  offer 
a  basis  for  judgment  on  whether  these  operations  have  been  efficiently 
conducted,  as  well  as  to  suggest  how  they  may  be  most  efficiently  con- 
ducted during  the  coming  period.  Also,  the  matter  of  efficiency  is 
a  relative  one.  The  fact  that  the  net  income  of  Taylor,  Johnson 
and  Company  for  the  year  1920  was  more  than  12  per  cent  on  the 
capital  invested  shows  that  the  management  could  hardly  have  been 
entirely  inefficient.  But  if  this  represents  a  lower  rate  of  return  on 
investment  than  that  secured  in  the  previous  year,  the  showing  of  this 
fact  will  lead  to  an  inquiry  whether  the  management  has  been  less 
efficient  or  whether  the  lower  rate  of  return  is  due  to  other  causes. 
A  form  of  report  which  presents  a  comparison  of  income  and  expenses 
of  the  current  year  with  income  and  expenses  of  one  or  more  previous 
years  may  not  only  raise  questions  of  this  nature  but  may  in  some 
cases  also  indicate  the  answers. 

Such  a  comparison  is  still  further  facilitated  if  each  of  the  im- 
portant items  in  the  statement  of  profit  and  loss  for  each  year  is 
expressed  hi  terms  of  its  percentage  of  some  other  item  on  that 
statement  which  is  taken  as  the  base  figure.  This  base  figure  may 
be  either  gross  sales  or  net  sales.  In  the  illustration  which  follows, 


FINANCIAL  REPORTS 


359 


gross  sales  is  used  as  100  per  cent  for  purposes  of  establishing  compari- 
sons between  various  items  of  expense  and  income  for  the  same 
period,  and  between  the  ratios  that  such  items  have  to  sales  in  the 
different  periods. 

As  indicated  previously  in  the  discussion  of  the  comparative  bal- 
ance sheet,  the  comparative  statement  of  profit  and  loss  is  also  of 
considerable  value  in  interpreting  certain  items  appearing  on  the  for- 
mer statement.  A  comparative  statement  of  profit  and  loss  for 
Taylor,  Johnson  and  Company  for  the  two  years  ending  December 
31,  1920,  is  shown  below: 

TAYLOR,  JOHNSON  AND  COMPANY 

COMPARATIVE  STATEMENT  OF  PROFIT  AND  Loss  FOR  THE  Two  YEAKS  ENDING 
DECEMBER  31,  1920 


1919 

Per- 
centage 

1920 

Per- 
centage 

Gross  sales  

165,300 
4,850 

00 

00 

242,500 
4,630 

oo 
oo 

IOO 

1-9 
98.1 

64-7 
33-4 

2.6 
7-1 

2.7 

2.2 
5-3 

19.9 

I3-S 
2.17 

15.67 
1.9 

13-7 

182,745 
5,420 

00 
00 

263,500 
6,250 

00 
00 

IOO 

2.4 

97.6 
70.8 

26.8 

2.1 

5.8 
3-4 
1.8 
4-4 

16.5 
10.2 

1.7 

II.  9 
1.7 

IO.2 

Net  sales  

237,870 
157.050 

oo 

00 

257,250 

186,150 

00 

00 
00 

oo 

00 

00 

Cost  of  goods  sold: 
Gross  purchases  

Less  purchase  deductions.  . 
Net  purchases  .  .         .   . 

160,450 
i,7S° 

'00 
00 

177,325 
»,525 

00 
00 

Freight,  express,  and  cart- 
age in  

Add  inventory,  Jan.  i  .  .  .  . 

Less  inventory,  Dec.  31  ... 
Cost  of  goods  sold  
Gross  profit  on  sales.  .  .  . 

Operating  expenses: 
Buving  expenses  

162,200 
47,650 

00 
00 

178,850 
52,800 

00 
00 

200,850 
52,800 

00 
00 

231,650 
45,5oo 

00 
00 

6,250 
17,300 
6,500 
5,250 
12,650 

00 

oo 

00 
00 
00 

5,300 
15,420 
6,215 
4,800 
12,350 

00 

00 
00 
00 
00 

80,820 

47,950 

00 

00 

00 
00 

71,100 

44,085 

Selling  expenses  

Delivery  expenses  

Credit  and  collection  expenses 
Administrative  expenses  .... 

Net  profit  on  sales  
Non-operating  income  

32,870 

5,220 

27,015 
4,465 

Gross  income  

38,090 
4,620 

00 
00 

00 

31,480 
4,470 

oo 
oo 

Other  deductions  from  income  . 
Net  income  .  .  r  

33,470 

27,010 

00 

This  statement  of  profit  and  loss  is  somewhat  condensed.     Some 
of  the  items,  such  as  sales  deductions,  different  groups  of  operating 


360  PRINCIPLES  OF  ACCOUNTING 

expenses,  non-operating  income,  and  other  deductions  from  income 
might  well  be  supported  by  analytical  statements  if  so  desired,  but 
for  purposes  of  comparison  it  is  doubtful  if  many  of  the  parties  who 
make  use  of  this  report  would  ever  refer  to  them.  For  the  purposes 
of  this  illustration  these  supplementary  reports  are  omitted,  although 
a  business  of  the  size  of  the  one  indicated  by  the  foregoing  state- 
ments, might  do  well  to  have  such  reports  prepared. 

A  study  of  the  comparative  statement  of  profit  and  loss  shown  in 
the  foregoing  illustration  will  reveal  several  significant  facts  with 
regard  to  the  financial  condition  of  the  company  and  with  regard  to 
its  operating  policy  during  the  year  1920.  In  the  first  place,  it  will  be 
seen  that  the  facts  revealed  with  regard  to  the  operations  of  the  cur- 
rent year  bear  out  the  conclusion  drawn  from  the  facts  in  the  com- 
parative balance  sheet,  to  the  effect  that  the  company  was  reducing 
its  inventory  hi  anticipation  of  a  period  of  falling  prices.  It  also 
indicates  that  the  company  sold  more  goods  than  in  the  preceding 
period,  but  at  a  lower  gross  profit.  Thus  not  only  is  the  percentage 
of  gross  profit  lower  but  also  the  actual  amount  of  gross  profit  is  less. 
Assuming  that  the  trade  is  entering  into  a  period  of  falling  prices, 
this  would  seem  to  indicate  a  wise  policy,  hi  accepting  a  reasonable 
profit  on  the  goods  now  on  hand  and  thereby  reducing  their  inventory, 
with  the  expectation  of  replacing  them  on  a  falling  market.  Another 
point  to  be  noted  is  that  the  company  has  apparently  depended  on 
lower  prices  as  an  inducement  to  its  customers  to  purchase  rather 
than  by  increasing  its  selling  and  other  operating  expenses.  This 
is  indicated  by  the  fact  that  the  opera  ting  expenses  have  been  reduced, 
not  only  relatively,  as  indicated  by  the  percentages,  but  absolutely  as 
well.  The  net  profit  is  considerably  lower  in  1920  than  in  the  preceding 
year,  both  absolutely  and  in  terms  of  its  ratio  to  sales.  It  is  still  quite 
satisfactory  in  amount,  however,  and  does  not  necessarily  indicate 
that  the  management  has  been  inefficient.  It  is  probable  that  the 
profits  for  the  past  few  years  have  been  unusually  high,  owing  to  the 
rising  market,  and  it  would  seem  that  the  management  is  exercising 
excellent  judgment  in  protecting  the  company  as  far  as  possible  from 
heavy  losses  which  might  result  if  a  period  of  falling  prices  should 
find  them  with  a  heavy  inventory  of  goods.  Also,  it  is  not  unlikely 
that  the  company  may  have  created  good  will  among  its  customers  by 
the  price  concessions  which  it  has  made,  thus  building  up  future  trade. 


FINANCIAL  REPORTS  361 

There  are  other  comparisons  for  which  such  a  statement  furnishes 
the  basis,  but  the  foregoing  discussion  should  furnish  a  sufficiently 
clear  idea  of  the  uses  which  may  be  made  of  such  a  statement,  as  well 
as  the  advantages  of  expressing  the  important  items  on  such  a 
statement  in  terms  of  percentages  of  gross  sales. 

The  statement  of  receipts  and  disbursements.  Another  form  of 
report  which  may  well  be  presented  is  a  statement  of  cash  receipts 
and  disbursements.  As  explained  in  the  chapters  dealing  with  the 
cash  records,  information  of  this  nature  is  usually  analyzed  in  sufficient 
detail  in  the  cash  journals,  so  that  a  glance  at  the  footings  of  their 
columns  would  yield  rather  complete  information.  This  does  not 
mean,  however,  that  a  report  of  this  nature  may  not  be  worth  while 
to  the  management,  who  can  hardly  be  expected  to  draw  their 
information  from  the  books  of  original  entry. 

Such  a  statement  would  not  be  at  all  complex  in  form,  and  does 
not  require  any  lengthy  discussion.  It  would  ordinarily  be  prepared 
monthly,  and  would  be  more  valuable  if  presented  in  comparative 
form.  Such  a  form  might  well  provide ,  the  basis  of  comparison 
between  receipts  and  expenditures  for  the  current  month  with  those 
of  each  previous  month  in  the  current  year,  and  possibly  with  those  of 
the  same  month  in  one  or  more  previous  years.  For  purposes  of 
illustration  the  form  may  be  shown  for  a  single  month.  Such  an 
illustration  follows: 

WILSON  AND  COMPANY 

STATEMENT  OF  RECEIPTS  AND  DISBURSEMENTS  FOR  THE  MONTH  ENDED 
JANUARY  31,  1920 

Balance,  January  i,  1920 $24,275.00 

Receipts: 

Accounts  receivable      ....  $78,500.00 

Cash  sales 24,700.00 

Notes  receivable 8,500.00 

Loans  secured  from  banks  .       .       .  10,000.00 

Sale  of  mortgage  bonds       .       .       .  50,000.00 

Interest  on  notes  receivable        .       .  350.00 

Miscellaneous 1,200.00 


Total  receipts $173,250.00 

Total  accountability  v $197,525.00 


362  PRINCIPLES  OF  ACCOUNTING 

Disbursements: 

Accounts  payable         ....  $63,000.00 

Notes  payable 32,500.00 

Interest  on  notes  payable    .       .       .  1,300.00 

Operating  expenses       ....  9,800.00 

Non-operating  expenses       .        .       .  2,750.00 

Purchase  of  delivery  equipment        .  1,750.00 

Paid  contractor  (new  building)  .       .  27,000.00 


Total  disbursements 138,100.00 

Balance,  January  31,  1920 $  59,425.00 

A  few  transactions  are  purposely  assumed  to  have  occurred  in  this 
month  which  would  not  occur  every  month,  or  in  the  ordinary  course 
of  operation.  Thus  the  company  is  assumed  to  have  received  money 
from  the  sale  of  its  bonds  and  to  have  applied  part  of  this  in  paying 
the  contractor  who  is  constructing  their  new  building,  for  the  con- 
struction of  which  the  bonds  were  presumably  issued.  This  and  the 
purchase  of  some  additional  delivery  equipment  are  the  only  items 
which  do  not  represent  the  regular  monthly  routine  business 
operations. 


QUESTIONS  FOR 'CLASS  DISCUSSION 

What  is  an  "exhibit"  in  the  accounting  sense  of  the  word  ?  Name  the 
"exhibits"  usually  prepared  and  explain  the  use  of  each.  Discuss  the 
importance  of  each  with  relation  to  the  others  and  with  relation  to 
other  forms  of  reports  that  might  be  prepared. 

Businesses  today  maintain  more  elaborate  accounting  systems  than  they 
did  a  few  years  ago,  so  that  there  is  considerably  more  data  available 
with  respect  to  the  financial  condition  and  operations  of  the  typical 
business  now  than  there  was  formerly.  But  the  balance  sheets  and 
statements  of  profit  and  loss  published  now  are  considerably  more  brief 
than  those  published  a  few  years  ago.  How  do  you  account  for  this  ? 
Does  it  mean  that  there  is  less  information  available  in  the  published 
reports  of  businesses  now  than  formerly  ? 

Assume  that  every  item  shown  by  the  reports  of  Taylor,  Johnson  and 
Company  were  five  times  as  large.  Would  this  make  desirable  any 
modifications  in  the  forms  of  the  "exhibits"  prepared  for  that  com- 
pany? On  the  basis  of  the  foregoing  assumption,  what  "schedules" 
and  "analytical  statements"  should  accompany  the  three  "exhibits"? 


FINANCIAL  REPORTS  363 

4.  Who  are  the  interested  parties  to  be  served  by  the  reports  of  Taylor, 
Johnson  and  Company,  as  outlined  by  you  in  answer  to  Question  3  ? 
Would  the  information  furnished  by  these  reports  be  all  that  is  required 
by  the  government  for  purposes  of  the  Federal  Income  Tax  ?    Would 
it  be  all  that  is  required  by  a  banker  to  whom  the  company  is  applying 
for  a  loan  ?    Would  it  completely  answer  tlje  requirements  of  the  sales 
manager  ?    the  treasurer  ?    Discuss. 

5.  Should  you  expect  the  stock  of  this  company  to  be  quoted  on  the 
market  on  December  31,  1920,  at  a  higher  or  a  lower  figure  than  on 
December  31,  1919?    Give  reasons  for  your  answer. 

6.  Do  you  agree  with  all  the  conclusions  stated  in  the  discussion  given 
above  in  connection  with  the  comparative  balance  sheet  of  Taylor, 
Johnson  and  Company?     Can  you  point  out  anything  of  significance 
which  was  omitted  from  that  discussion  ? 

7.  Suppose  you  are  a  banker  and  are  asked  to  pass  on  the  application 
of  Taylor,  Johnson  and  Company  for  a  $30,000  loan  for  sixty  days. 
Woxild  you  grant  it  ?    Give  reasons  for  your  answer. 

8.  Define  or  criticize  the  policy  followed  by  the  company  mentioned  above 
during  the  year  1920,  as  indicated  by  the  three  reports  given  above. 

REFERENCES  FOR  FURTHER  STUDY 

GREE'NDLINGER,  LEO,  Financial  and  Business  Statements,  chaps,  iii  and  iv. 
WILDMAN,  J.  R.,  Principles  of  Accounting,  chap.  xlvi. 
DICKINSON,  A.  L.,  Accounting  Practice  and  Procedure,  chaps,  ii  and  iii. 
HATFIELD,  H.  R.,  Modern  Accounting,  chaps,  iii  and  xv. 
KSQUERRE,  PAUL-JOSEPH,  Applied  Theory  of  Accounts,  chaps,  xxxv,  xxxvi, 
and  xxxvii. 


CHAPTER  XXXI 

THE  GRAPHICAL  METHOD  OF  PRESENTING 
ACCOUNTING  FACTS 

Diversified  reports  required  by  management.  In  chapter  xxx  it  was 
pointed  out  that  the  need  of  the  management  for  information  could 
not  be  satisfied  by  the  balance  sheet  and  the  statement  of  profit  and 
loss  alone,  or  even  by  the  additional  financial  reports  discussed  in  that 
chapter.  With  the  growth  in  size  of  the  average  business  unit,  and 
with  the  increased  specialization  of  managerial  functions,  there  has 
arisen  the  need  for  additional  special  reports  for  managerial  use. 
An  example  of  the  need  for  such  diversification  of  reports  is  found  in 
the  reports  which  are  drawn  up  to  show  sales  analysis.  These  reports 
must  be  so  prepared  as  to  show  sales  analyses  on  several  bases,  each 
such  basis  of  analysis  being  determined  by  the  kind  of  questions 
which  some  one  of  the  functional  managers  wants  answered.  Thus 
the  merchandise  man,  or  purchase  manager,  might  want  a  report 
classifying  sales  by  commodities.  The  sales  manager  might  desire 
reports  classifying  sales  by  territories,  by  salesmen,  or  on  both  these 
bases.  The  treasurer,  whose  problems  are  financial  in  their  nature, 
might  desire  a  report  which  would  classify  sales  on  the  basis  of  the 
credit  terms  on  which  they  had  been  made.  And  not  only  are  reports 
of  this  sort  needed,  but  also  statements  which  make  possible  the 
comparison  of  such  facts,  as  between  branches  or  departments  of  the 
business,  and  as  between  different  periods  of  time. 

The  use  of  statistical  method.  If  these  reports  are  to  give  the 
managers  for  whom  they  are  prepared  the  information  most  desired 
by  them,  and  in  the  most  available  form,  it  will  be  necessary  for  the 
accountant  to  call  to  his  aid  methods  of  presentation  which  are  ordi- 
jiarily  termed  statistical  methods.  The  statistical  method,  in  the 
best  meaning  of  the  term,  implies  the  gathering,  in  numerical  terms, 
of  the  information  needed  for  answering  a  certain  question  or  revealing 
a  certain  tendency,  and  the  presentation  of  this  information  in  as 
clear  a  manner  as  possible. 

364 


GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT  FACTS    365 

Thus  if  the  sales  manager  of  a  large  wholesale  establishment 
wishes  to  know  the  ratio  between  expenditures  incurred  for  adver- 
tising in  a  certain  territory  during  a  certain  period  of  time,  and  the 
amount  of  the  sales  made  in  that  territory  during  the  same  period, 
the  answering  of  his  query  in  a  satisfactory  manner  will  involve  the 
use  of  statistical  method.  Assuming  that  the  records  of  the  business 
have  been  properly  kept  with  a  view  to  answering  such  a  question, 
and  that  the  information  needed  is  therefore  available,  it  might  appear 
from  these  records  that  the  sales  made  in  X  territory  during  November 
amounted  to  $72,000,  while  the  advertising  expense  incurred  during 
that  month  amounted  to  $6,000.  Given  this  information,  there  are 
several  methods  by  which  it  may  be  presented  to  the  sales  manager. 
Some  possible  methods  of  such  presentation  are: 

1.  A  simple  memorandum  to  the  effect  that  the  sales  made  in  X 
territory  during  November  amounted  to  $72,000,  with  an  advertising 
expense  of  $6,000.    This  is  a  mere  statement  of  facts  with  no  attempt 
at  interpretation.    For  this  reason,  if  similar  information  is  furnished 
in  this  form  for  all  the  sales  territories,  the  full  significance  of  the 
comparisons  involved  would  not  become  evident  to  the  executive 
without  the  expenditure  of  some  time  and  energy  on  his  part  in  study- 
ing the  relationships  expressed  by  the  figures  submitted. 

2.  A  report  to  the  effect  that  the  sales  made  in  X  territory  for 
November  were  twelve  times  the  advertising  expense  incurred  for 
that  territory  during  that  month.     This  is  stating  the  answer  hi  the 
form  of  a  ratio,  and  is  more  suggestive  than  the  first  method,  because 
a  comparison  between  the  two  items  is  indicated. 

3.  A  report  to  the  effect  that  the  advertising  expense  for  X  terri- 
tory during  November  was  8^  per  cent  of  sales.    This  method  is  not 
very  different  from  that  of  expressing  the  relation  in  the  form  of  a 
ratio,  but  is  preferable  for  the  reason  that  it  is  somewhat  easier  to 
understand  the  meaning  of  percentages  taken  on  a  common  base, 
the  base  here  being  the  amount  of  sales.    Thus  if  the  sales  manager 
desired  also  a  comparison  between  sales  and  salesmen's  salaries  for 
the  same  territory  and  period,  as  he  probably  would,  and  the  sales- 
men's salaries  amount  to  $9,000,  it  would  be  better  to  report  that 
advertising  expense  was  83  per  cent  and  salesmen's  salaries  \i\  per 
cent  of  sales  than  to  report  that  sales  were  1 2  times  the  first  item  and 
9  times  the  second,  since  the  percentage  method  affords  not  only  a 


366  PRINCIPLES  OF  ACCOUNTING 

comparison  between  sales  and  each  of  the  two  expense  items  but  also 
a  basis  of  comparison  between  the  two  items  of  expense. 

4.  A  chart  or  graph  indicating  a  comparison  between  the  two 
items.  Such  a  comparison  might  be  expressed  by  means  of  two  bars 
of  equal  width,  the  respective  lengths  of  which  would  indicate  the 
relationship  between  the  two  amounts  hi  question,  as  follows: 

CHART  I 

$72,000 


$6,000 


a,  Sales  in  X  territory — November 

b,  Advertising  expense  for  X  territory — November 


This  last  method  o'f  presenting  statistical  data  is  known  as  the 
graphic  method,  and  is  particularly  suitable  for  the  presentation  of 
certain  types  of  information,  as  will  presently  appear. 

Further  illustration  of  the  statistical  method.  To  illustrate  further 
the  presentation  of  statistical  data  concerning  business  operations, 
it  may  be  assumed  that  a  certain  department  store  keeps  records 
which  furnish  the  following  information  concerning  the  operations  of 
each  department:  (i)  gross  sales;  (2)  sales  returns  and  allowances; 
(3)  net  sales;  (4)  cost  of  goods  sold;  (5)  gross  profit  on  sales;  (6)  sales 
salaries;  (7)  advertising  expense;  (8)  delivery  expense;  (9)  general 
overhead  expense  (pro-rated  to  the  department) ;  (10)  net  operating 
profit. 

Assuming  further  that  the  records  are  kept  in  such  a  manner  as 
to  make  this  information  available  by  months,  the  information  concern- 
ing the  operations  of  a  given  department  for  a  year  may  be  tabulated 
to  show  each  of  these  items  for  each  month  of  the  year,  thus  making 
it  possible  to  compare  different  items  for  the  same  month,  and  also  to 
compare  the  amount  of  a  given  item  for  one  month  with  the  amount 
of  the  same  item  for  any  other  month.  Such  a  tabulation,  showing 
the  facts  with  regard  to  the  operations  of  Department  A  for  the 
year  ended  December  31,  1919,  is  shown  on  page  368. 

There  are  several  comparisons  which  may  be  made  on  the  basis 
of  the  information  furnished  by  the  foregoing  tabulation,  as  well  as 


GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT  FACTS    367 


several  ways  in  which  such  comparisons  may  be  presented.  For 
example,  if  it  is  reported  that  gross  sales  for  January  were  twenty 
times  the  amount  of  advertising  expense,  for  February  thirty-one 
and  one-tenth  times  that  item,  and  so  on  for  the  remaining  months, 
this  would  be  expressing  comparisons  between  these  two  items  for 
different  months  of  the  year  in  terms  of  ratios.  These  ratios  could 
then  be  shown  for  each  month  to  afford  a  comparison  of  the  ratios 
for  different  months  of  the  year,  as  follows: 

RATIO  OF  GROSS  SALES  TO  ADVERTISING  EXPENSE, 
DEPARTMENT  A 

FOR  YEAR  ENDED  DECEMBER  31,  1919  (BY  MONTHS) 


Jan. 

Feb. 

Mar. 

April 

May 

June 

July 

Aug. 

Sept. 

Oct. 

Nov. 

Dec. 

For  Year 

21 

33-i 

5°-3 

3° 

25 

40.  2 

5° 

25.8 

21.3 

26.3 

32.7 

17 

27 

Assuming  that  gross  sales  is  taken  as  the  basis  of  comparison,  a 
comparison  between  this  item  and  any  other  of  the  items  previously 
mentioned  may  be  shown  by  the  method  just  indicated.  For  example, 
the  ratio  of  gross  sales  to  cost  of  goods  sold,  or  to  sales  salaries,  may 
be  shown  for  the  year,  and  for  each  month  in  the  year. 

Another  method  by  means  of  which  different  items  may  be 
compared  for  any  one  month  is  the  use  of  percentages,  as  indicated 
in  the  earlier  discussion.  Thus,  taking  the  gross  sales  for  the  month 
as  the  base  figure,  or  100  per  cent,  it  is  possible  to  show  other  items 
for  that  month  in  terms  of  their  percentages  of  gross  sales.  This 
method  of  comparison  may  be  illustrated  by  a  table  showing  gross 
sales,  sales  returns  and  allowances,  net  sales,  cost  of  goods  sold,  and 
gross  profit  on  sales,  for  the  first  three  months  of  the  year,  expressed 
for  each  month  in  terms  of  the  percentage  of  each  item  of  the  amount 
of  gross  sales  for  that  month.  In  practice  such  a  table  would  probably 
be  extended  to  include  all  the  items  listed  in  the  table  given  and  to 
cover  all  of  the  twelve  months  of  the  year.  The  method  employed, 
however,  is  sufficiently  well  indicated  by  the  partial  tabulation  shown 
on  page  369. 

The  graphic  method  illustrated.  Still  another  and  very  useful 
method  of  presenting  statistical  information  is  by  means  of  charts, 


368 


PRINCIPLES  OF  ACCOUNTING 


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GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT  FACTS    369 


DEPARTMENT  A 

PERCENTAGES  TO  GROSS  SALES  OF  RETURNS  AND  ALLOWANCES,  NET  SALES,  COST 

OF  GOODS  SOLD,  AND  GROSS  PROFIT  ON  SALES,  FOR  THE  FIRST  THREE 

MONTHS  OF  THE  YEAR  ENDED  DECEMBER  31,  1919 


PERCENTAGES 

January 

February 

March 

Gross  sales  

IOO.O 

IOO.O 

IOO.O 

Sales  returns  and  allowances  

c.o 

S.o? 

4.6 

Net  sales                  

04-  I 

94.07 

9<;.4 

Cost  of  goods  sold        

6?  .2 

68.0 

70.  1 

Gross  profit  on  sales  .         

28.0 

26.07 

2<.  * 

curves,  or  graphs,  in  such  a  way  as  to  appeal  directly  to  the  eye. 
This  method  may  be  illustrated  first  by  the  use  of  what  is  known  as 
the  curve.  Several  types  of  curves  are  employed  by  statisticians  and 
for  different  purposes,  but  the  curves  which  will  be  made  use  of  in  the 
following  illustrations  are  of  a  very  simple  type,  and  all  deal  with  the 
same  sort  of  data  after  the  same  manner. 


CHART  II 


SIZOjOOO 
100,000 
80,000 
60.000 
40,000 
20,000 


JAN  FEB   MAR   APR  MAY    JUN  JUL    AUG   SEP    OCT   NOV    DEC 

Department  A — Curve  showing  Gross  Sales  (by  months)  for  the  year  ended 
December  31,  1919. 


370  PRINCIPLES  OF  ACCOUNTING 

The  foregoing  illustration  shows  a  curve  for  the  gross  sales  of 
Department  A,  plotted  by  months,  for  the  year  1919.  An  exami- 
nation of  this  curve  indicates  that  sales  in  this  department  were  high 
during  the  January  and  February  sales^  lower  in  March,  climbing 
again  in  April  and  May,  high  in  the  August  sales,  higher  still  in 
September,  after  which  they  fall  off  somewhat,  but  reach  their  peak 
during  the  holiday  season. 

This  curve,  showing  the  comparison  of  sales  by  months  for  a 
single  year,  at  once  suggests  several  other  interesting  comparisons. 
Thus  it  would  evidently  be  interesting  to  see  how  the  sales  of  the 
preceding  year,  plotted  by  months,  on  the  same:  base  and  to  the  same 
scale,  would  compare  with  those  of  the  current  year.  To  prepare 
such  a  curve,  however,  it  would  be  necessary  to  assume  a  considerable 
amount  of  additional  data.  It  will  therefore  be  omitted,  though  with 
a  full  recognition  of  its  value  for  purposes  of  comparison. 

Comparison  of  gross  sales  with  net  sales.  In  the  tabulation  pre- 
viously given  of  the  more  important  data  concerning  the  operations 
of  Department  A  for  the  year,  it  will  be  noted  that  the  gross  sales 
and  the  amount  of  sales  returns  and  allowances  are  given  for  each 
month,  and  that  the  amount  of  net  sales  for  the  month,  which  is  the 
difference  between  the  two,  is  shown  as  the  third  item.  The  manager 
is  apt  to  be  concerned  with  the  fluctuations  of  the  sales  returns  and 
allowances  in  relation  to  the  gross  sales,  and  the  relations  between 
gross  sales  and  net  sales  for  each  month.  Two  curves  may  be  plotted 
for  his  inspection,  the  first  showing  a  comparison  between  gross  sales 
by  months  and  sales  returns  and  allowances  by  months,  the  second 
showing  a  comparison  between  gross  sales  and  net  sales,  both  by 
months.  The  second  would  to  some  extent  serve  the  purposes  of 
both,  since  the  variations  that  will  be  shown  by  this  curve  between 
gross  sales  and  net  sales  from  month  to  month  will  serve  to  indicate 
fairly  well  the  fluctuations  in  the  amount  of  sales  returns  and  allow- 
ances. The  first  chart  suggested  will  be  omitted  here,  and  only  the 
second  one  shown  for  purposes  of  illustration  (Chart  III). 

Comparison  of  gross  sales  and  cost  of  goods  sold.  Another  signifi- 
cant comparison  that  can  be  made  on  the  basis  of  the  data  furnished 
by  the  table  on  page  368  is  one  between  the  gross  sales  by  months 
and  the  cost  of  goods  sold,  also  by  months.  Such  a  comparison  is 
shown  by  the  two  curves  on  Chart  IV,  both  of  which  are  plotted  on 
the  same  base  and  to  the  same  scale. 


8120,000 
100,000 
80,000 
60000 
-10,000 
20,000 


JAN    FEB  MAR   APR  MAY    JUN    JUL  AUG    SEP    OCT    NOV   DEC 
Department  A — Chart  showing  comparison  between  Gross  Sales  and  Net 
Sales  (by  months)  for  the  year  ended  December  31,  1919. 

CHART  IV 

$120,000 


100,000 


80,000 


60,000 


40,000 


20.000 


JAN     PEB  MAf\    APf\  MAY    JUN    JUL    AUG    SEP    XT    NOV    DEC 
Department  A — Chart  showing  comparison  between  Gross  Sales  and  the 
cost  of  the  goods  sold  (by  months)  for  t£e  year  ended  December  31,  1919. 


372 


PRINCIPLES  OF  ACCOUNTING 


An  examination  of  the  two  curves  shown  on  this  chart  shows  a 
tendency  toward  a  fairly  close  correspondence  in  the  movements  of 
the  two  lines.  However,  it  is  to  be  seen  that  the  margin  between 
the  two  fluctuates  somewhat  from  month  to  month,  not  only  in  its 
amount  but  also  in  its  relation  to  the  amount  of  gross  sales.  Another 
valuable  comparison  would  be  shown  by  a  chart  on  which  was  plotted 
the  curves  for  net  sales  and  cost  of  goods  sold,  both  by  months.  In 
this  case  the  margin  between  the  two  would  represent  the  amount  of 
gross  profit  on  sales.  Such  a  chart  would  reveal,  for  instance,  that 
a  high  percentage  of  gross  profit  was  realized  in  April,  in  September, 
and  in  December,  as  compared  with  that  realized  in  the  other  months 
of  the  year. 

Comparison  of  gross  sales  and  advertising  expense.  It  is  altogether 
probable  that  .the  sales  manager  will  desire  a  comparison  between 
gross  sales  and  the  advertising  expense  incurred  in  making  these 
sales,  by  months.  Such  a  comparison  is  presented  by  the  two  curves 
shown  on  the  following  chart: 


CHART  V 


$120.000 
100000 
80000 
60000 
40000 
20000 


JAN    FED  MAPv  APR  MAY    JUN    JUL    AUG    SEP    OCT    NOV    DLC 

Department  A — Chart  showing  comparison  between  Gross  Sales  and  Adver- 
tising Expense  (by  months)  for  the  year  ended  December  31,  1919. 


GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT  FACTS    373 


It  is  at  least  evident  from  this  chart  that  advertising  expense 
has  not  been  charged  to  this  department  on  the  basis  of  sales,  since  the 
fluctuations  of  the  two  curves  are  not  always  in  the  same  direction. 
Thus  in  April  the  advertising  expense  is  seen  to  be  lower  than  in  May, 
while  the  sales  in  April  were  higher  than  the  sales  for  May. 

Comparison  of  gross  sales  and  operating  expenses.  Another  desir- 
able comparison  is  one  between  total  sales  and  total  operating  expense. 
A  chart  showing  such  a  comparison  is  given  below. 


CHART  VI 


$120.000 


100.000 


60,000 


60.000 


40000 


20,000 


JAN     FEB   MM   APA  MAY    JUN    JUL    AUG    SEP     OCT     NOV    DEC 

Department  A — Chart  showing  comparison  between  Gross  Sales  and  Total 
Operating  Expense  (by  months)  for  the  year  ended  December  31,  1919. 

Inspection  of  the  two  curves  reveals  that  in  every  month  an  in- 
crease in  sales  has  been  accompanied  by  an  increase  in  operating 
expense  and  vice  versa,  though  not  always  in  the  same  proportion. 
Any  questions  which  may  be  raised  by  a  study  of  this  chart  will 
require  a  reference  to  the  table  in  which  the  analysis  of  operating 
expense  by  months  is  shown,  and  will  probably  require  an  investiga- 
tion which  will  demand  information  of  an  even  more  detailed 
nature. 


374 


PRINCIPLES  OF  ACCOUNTING 


Comparison  of  gross  sales  and  net  profit.     A  comparison  of  gross 
sales  by  months  with  net  operating  profits  by  months  is  shown  in 

the  following  chart: 

CHART  VH 
$120,000 


100,000 


8(XOOO 


60,000 


40.000 


20,000 


JAN    FE1B    MAR  APR   MAY    JUN    JUL    AUG    SEP    OCT    NOV    DEC 

Department  A — Chart  showing  comparison  between  Gross  Sales  and  Net 
Operating  Profit  (by  months)  for  the  year  ended  December  31,  1919. 

The  amount  of  net  operating  profit  fluctuates  more  sharply  from 
month  to  month  in  proportion  to  its  size  than  does  the  amount  of 
gross  sales.  This  is  quite  to  be  expected,  and  may  be  explained  by  a 
study  of  the  fluctuations  in  the  amounts  of  the  various  items  which 
were  to  be  deducted  from  the  amount  of  gross  sales  before  arriving 
at  the  net  operating  profit. 

Other  methods  of  graphical  presentation.  Another  means  of  showing 
a  comparison  between  figures  graphically  is  by  the  use  of  bars  or 
rectangles  of  similar  width,  whose  length  furnishes  the  basis  for 
comparison.  A  case  in  which  this  method  might  well  be  employed 
is  "found  in  the  comparison"  of  total  sales  for  the  current  year  with 
total  sales  for  the  preceding  year.  Assuming  gross  sales  for  the  pre- 
ceding year  to  have  been  $1,011,000,  and  ascertaining  the  sales  for  the 
current  year  to  total  $1,208,100,  such  a  comparison  is  shown  by  the 
following  chart: 


IQl8 


1919 


GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT  FACTS        375 
CHART  VIII 

^••••••^•^^•^B 

$I,OII,OOO 

$1,208,100 


Department  A — Chart  showing  comparison  between  total  sales  for  year 
ended  December  31,  1919,  with  total  sales  for  year  ended  December  31,  1918. 

The  rectangle  or  bar  can  also  be  used  as  a  device  for  showing  a 
comparison  of  parts  with  the  whole  which  they  make  up.  For  ex- 
ample, if  the  gross  sales  for  January  are  taken  as  the  whole  with  which 
its  parts  are  to  be  compared,  a  rectangle  may  be  drawn  to  scale  to 
show  by  its  length  the  amount  of  this  total.  This  rectangle  may  then 
be  divided  into  cross-sections,  the  length  of  each  representing  the 
amount  of  one  of  the  deductions  which  must  be  made  from  gross 
sales  before  net  profits  can  be  ascertained.  The  last  remaining  cross- 
section  will  represent  the  amount  of  such  net  profits.  Still  another 
basis  of  comparison  is  furnished  if  similar  rectangles  are  drawn  for 
the  other  months  of  the  year,  all  drawn  to  the  same  scale  and  divided 
in  a  similar  manner.  This  use  of  the  bar  or  rectangle  in  graphic 
presentation  is  illustrated  by  the  chart  which  follows: 


CHART  IX 


Jan. 


2345 


2345 


Feb. 


Mar. 


Department  A — Chart  showing  relative  amounts  of  gross  sales,  deductions 
from  sales,  operating  expenses,  and  net  operating  profit  (by  months)  for  the  first 
three  months  of  the  year  ended  December  31,  1919. 

1.  Net  operating  profit  5.  Sales  salaries 

2.  General  overhead  expense  6.  Cost  of  goods  sold 

3.  Delivery  expense  7.  Returns  and  allowances 

4.  Advertising  expense 


376  PRINCIPLES  OF  ACCOUNTING 

Advantages  of  the  graphic  method.  A  few  simple  illustrations  have 
been  presented  and  discussed  in  this  chapter.  These  illustrations  of 
the  graphic  method  of  presenting  business  statistics  are  perhaps  not 
numerous  or  varied  enough  to  be  really  representative,  but  they  do 
serve  to  reveal  certain  advantages,  as  well  as  certain  weaknesses,  of 
this  manner  of  presentation.  The  more  obvious  advantages  may  be 
listed  as  follows: 

1.  The  graphic  method  of  presenting  facts  appeals  directly  to  the 
eye,  and  is  sure  to  command  attention. 

2.  It  brings  out  comparisons  or  tendencies  in  a  more  striking 
manner,  and  renders  the  facts  shown  easier  of  interpretation  than  do 
other  methods. 

3.  A  busy  executive  can  review  in  a  given  time  a  much  greater 
amount  of  information  presented  in  this  form  than  if  this  information 
were  presented  in  some  other  form. 

4.  By  the  use  of  curves  it  is  easier  to  show  a  continuity  of  certain 
tendencies  over  a  period  of  time  than  it  is  to  show  such  continuity 
by  other  methods. 

Limitations  of  the  graphic  method.  From  a  careful  consideration 
of  the  illustrations  given  in  the  preceding  pages  of  this  chapter,  it 
should  become  apparent  to  the  student  that  the  graphic  method  has 
not  only  its  advantages  but  also  certain  limitations.  The  limitations 
of  the  use  of  the  graphic  method  which  most  readily  suggest  them- 
selves are  as  follows: 

1.  Only  a  very  limited  range  of  information  can  be  presented  to 
advantage  on  one  chart.    This  can  be  readily  seen  by  comparing  the 
information  presented  by  any  one  of  the  several  charts  illustrated 
above,  or  by  all  of  them,  with  the  amount  of  information  furnished 
by  the  single  table  upon  which  they  are  all  based. 

2.  While  showing  certain  tendencies  very  clearly,  the  chart  does 
not  usually  furnish  exact  information  in  such  a  form  as  can  be  readily 
stated  in  terms  of  definite  numbers.    In  other  words,  a  chart  cannot 
be  easily  quoted.     Graphic  presentation  of  facts  is  usually  not  suffi- 
cient in  itself,  but  needs  to  be  supplemented  by  figures.    Thus,  in  the 
last  preceding  illustration  there  is  shown  comparisons  of:  (i)  totals, 
and  (2)  the  parts  into  which  those  totals  may  be  divided.    A  little 
study  of  this  chart  will  show  that  it  will  be  much  more  enlightening 
if  each  section  of  each  bar  there  shown  is  also  marked  to  indicate  the 


GRAPHICAL  METHOD  OF  PRESENTING  ACCOUNT  FACTS     377 

number  of  dollars  represented  by  such  section,  and  also  the  percentage 
of  the  whole  which  such  section  represents. 

3.  The  amount  of  training  and  caution  necessary  for  the  proper 
use  of  the  graphic  method.  This  is  necessary: 

a)  On  the  part  of  the  one  submitting  the  report.  A  variation  in 
the  base,  the  scale,  or  the  basis  of  comparison  may  create  a  very 
different  impression  with  regard  to  a  given  set  of  facts,  and  if  not 
wisely  and  honestly  done  may  be  very  misleading. 

6)  On  the  part  of  the  one  to  whom  the  report  is  submitted  for 
inspection  and  interpretation.  If  such  reports  are  drawn  in  a  fashion 
tending  to  be  misleading,  they  are  more  misleading  than  almost  any 
arrangement  of  the  actual  figures  could  be.  Only  one  who  is  trained 
in  the  use  and  interpretation  of  statistics  would  know  enough  to  avoid 
reading  a  wrong  meaning  into  charts  which  are  carelessly,  ignorantly, 
or  dishonestly  prepared. 

Summary.  In  rendering  reports  with  regard  to  various  phases 
of  business  activity  to  the  managers  and  other  interested  parties,  the 
accountant  should  make  use  of  the  most  scientific  methods  of  pre- 
senting such  information  available  for  his  use.  This  means  that  the 
successful  accountant  must  have  a  working  knowledge  of  statistical 
method.  One  very  useful  way  of  bringing  information  to  the  attention 
of  those  for  whose  use  it  is  collected  is  by  means  of  "graphs  "  or  charts, 
which  present  such  information  graphically  or  pictorially.  This 
method  possesses  certain  very  evident  advantages,  but  it  must  be 
used  with  understanding  and  with  caution.  Where  the  graphic 
method  of  presentation  is  employed,  it  should  generally  be  used  in 
connection  with  and  supplementary  to  statistics  which  are  tabulated 
or  otherwise  reported  in  such  a  manner  as  to  show  the  exact  quantities 
involved,  thus  retaining  the  good  features  of  both  methods  of 
presentation  and  avoiding  so  far  as  is  possible  then-  dangers. 

QUESTIONS  FOR  CLASS  DISCUSSION 

i.  Assume  that  you  are  sales  manager  of  the  Way  Sagless  Spring  Com- 
pany, a  manufacturing  concern  turning  out  three  lines  of  product. 
The  company  advertises  nationally,  and  sells  to  dealers  all  over  the 
United  States.  Sales  are  made  by  salesmen  and  by  mail,  by  means  of 
catalogues.  The  sales  teritory  is  divided  into  five  parts,  with  a  sub- 
ordinate sales  manager  for.  each  territory.  Outline  the  information 


378  PRINCIPLES  OF  ACCOUNTING 

which  you  should  expect  the  accounting  department  to  furnish  you 
each  month. 

2.  How  much  of  the  information  shown  in  your  outline  could  be  advan- 
tageously shown  in  graphic  form  ?    [Make  a  list  of  such  charts  as  you 
would  ask  to  have  prepared.    What  use  could  advantageously  be  made 
of  percentages  ? 

3.  Assume  that  you  are  traffic  manager  for  the  Way  Sagless  Spring  Com- 
pany.   What  statistical  data  would  be  useful  to  you  in  planning  your 
work  ?    Can  you  suggest  any  charts  that  would  be  useful  to  you  in  this 
capacity  ? 

4.  To  what  member  of  the  organization  would  each  of  the  dharts  shown  in 
chapter  xxxi  probably  be  most  useful?    Prepare  a  memorandum  to 
accompany  each  of  the  charts  there  shown,  calling  attention  to  what 
you  consider  the  most  significant  thing  shown  by  each  such  chart. 

5.  You  are  appointed  head  of  the  accounting  department  of  a  wholesale 
hardware  business  which  has  six  departments  and  makes  sales  in  fifteen 
states.    You  wish  to  employ  an  assistant  who  is  an  expert  statistician, 
but  this  represents  an  innovation  and  the  general  manager  is  rather 
doubtful  as  to  its  wisdom.    Prepare  a  memorandum  to  the  general 
manager,  in  which  you  attempt  to  justify  your  proposal  to  employ 
such  an  assistant. 

6.  Assume  that  you  have  succeeded  in  getting  your  statistician,  and  that 
he  has  been  supervising  the  preparation  of  tables  and  charts  for  the  use 
of  various  members  of  the  staff.    The  sales  manager  finds  the  charts 
very  helpful,  and  suggests  that  it  would  be  a  saving  of  his  time  if  the 
reports  intended  for  him  should  be  presented  in  graphic  form  exclu- 
sively.   Should  you  accede  to  this  suggestion  ?    Prepare  a  memoran- 
dum on  the  subject,  addressed  to  the  sales  manager. 

REFERENCES  FOR  FURTHER  STUDY 

GREENDLINGER,  LEO,  Financial  and  Business  Statements,  chap.  ii. 
COPELAND,  M.  T.,  Business  Statistics,  chap,  i,  and  pp.  254-61,  267-72, 

381-86. 
FRANKLIN,  B.  A.,  Cost  Reports  for  Executives,  chap.  viL 


APPENDIX 

W.  C.  Harvey's  business  has  been  expanding  at  such  a  rate  that  he 
considers  it  desirable  to  have  a  considerably  larger  capital,  and  also  to  have 
another  person  associated  with  him  in  its  management.  He  therefore  enters 
into  an  agreement  with  H.  P.  Simmons  to  form  a  co-partnership  under  the 
name  of  Harvey  and  Simmons  for  the  purpose  of  dealing  in  hardware  and 
house  furniture. 

It  is  agreed  between  them  that  the  capital  of  the  partnership  is  to  be 
$30,000.  In  view  of  the  successful  start  made  by  Mr.  Harvey,  and  the 
desirable  relations  already  established  by  him,  Mr.  Simmons  agrees  to 
accept  Harvey's  present  investment  at  its  book  value,  and  to  allow  him  to 
include  in  the  statement  of  his  assets  an  item  of  good-will  sufficient  to  bring 
his  investment  up  to  $10,000.00.  Harvey  is  to  contribute  an  additional 
$5,000.00  in  cash,  and  Simmons  is  to  contribute  $15,000.00,  half  of  which 
must  be  in  cash,  and  the  remainder  in  cash  or  high-grade  collateral. 

The  articles  of  co-partnership  subscribed  to  by  the  two  parties  to  the 
agreement  are  as  follows: 

ARTICLES  OF  CO-PARTNERSHIP 

THESE  ARTICLES  OF  AGREEMENT,  made  and  entered  into  this  first  day 
of  June,  one  thousand  nine  hundred  and  eighteen,  by  and  between  W.  C. 
Harvey,  of  the  city  of  Chicago,  party  of  the  first  part,  and  H.  P.  Simmons,  of 
the  same  place,  party  of  the  second  part, 

WITNESSETH,  as  follows: 

1.  The  said  parties  above  named  agree  to  become  partners  in  the  retail 
hardware  and  furniture  business,  located  in  the  city  of  Chicago,  under  the 
firm  name  and  style  of  Harvey  and  Simmons,  said  partnership  to  continue 
for  five  years  from  the  date  hereof. 

2.  The  capital  of  the  said  partnership  shall  consist  of  thirty  thousand 
dollars  ($30,000.00),  contributed  as  follows:    W.  C.  Harvey  to  contribute 
his  present  retail  hardware  and  furniture  business,  conducted  by  him 
him  at  6540  Kinzie  Avenue,  said  business  to  be  valued  at  ten  thousand  dol- 
lars ($10,000.00),  including  the  good-will,  and  five  thousand  dollars  ($5,- 
ooo.oo)  additional  in  cash;    H.  P.  Simmon  to  contribute  fifteen  thousand 
dollars  ($15,000.00),  seven  thousand,  five  hundred  dollars  ($7,500.00)  of 
this  to  be  in  cash,  and  the  remainder  in  cash  or  collateral  which  shall 
prove  acceptable  to  W.  C.  JIarvey.    The  said  contributions  are  to  be  em- 
ployed as  a  common  fund  in  the  conduct  of  the  business,  for  their  mutual 
benefit  and  advantage. 

379  - 


380  PRINCIPLES  OF  ACCOUNTING 

3.  During  the  continuance  of  the  partnership  herein  mentioned,  each 
of  the  partners  shall  give  his  time,  skill,  and  attention  to  the  business, 
and  exert  his  best  powers  for  their  joint  interest,  profit,  benefit,  and  advan- 
tage, and  truly  buy,  sell,  and  trade  with  their  joint  stock,  and  the  increase 
thereof  in  the  said  business. 

4.  The  partners  shall  bear,  pay,  and  dicharge  between  them  all  expenses 
of  the  business;   all  losses  and  all  gains  arising  from  the  conduct  of  the 
business  shall  be  borne  and  divided  between  them  equally,  share  and  share 
alike. 

5.  For  the  time,  skill,  and  attention  given  to  the  business  W.  C.  Harvey 
shall  receive  the  sum  of  two  hundred  and  twenty-five  dollars  ($225.00)  per 
month,  and  H.  P.  Simmons  the  sum  of  two  hundred  dollars  ($200.00)  per 
month,  said  sum  in  both  cases  to  be  charged  to  the  salaries  account. 

6.  Each  of  the  partners  shall  be  credited  with  interest  at  6  per  cent 
per  annum  on  his  capital  investment,  the  amount  of  said  investment  to  be 
taken  as  of  the  first  of  each  month.    The  amount  of  such  interest  accruing 
to  each  partner  shall  be  credited  to  that  partner's  personal  account  at  the 
end  of  such  month. 

7.  No  withdrawals  in  excess  of  salary,  interest  earned,  and  profits 
may  be  made  by  either  partner  without  written  consent  of  the  other. 
Upon  such  withdrawals,  if  made,  the  partner  making  them  shall  be  charged 
6  per  cent  per  annum  until  such  deficit  shall  be  made  good. 

8.  All  the  transactions  of  the  partnership  shall  be  truly  entered  in 
double  entry  books  of  account,  and  the  same  are  to  be  audited  periodically 
by  a  certified  public  accountant.    On  the  thirty-first  day  of  December  of 
each  year  the  books  shall  be  closed  by  a  certified  public  accountant,  and 
the  net  profit  or  net  loss  for  the  year  ascertained  and  apportioned. 

9.  The  said  parties  hereby  mutually  agree  that  during  the  continuance 
of  the  said  partnership  neither  of  them  shall  indorse  any  note,  or  become 
surety  for  any  person,  without  the  written  consent  of  the  other  partner. 

10.  And  it  is  finally  agreed  that  at  the  termination  of  the  said  partner- 
ship the  said  partners,  each  to  the  other,  shall  and  will  make  a  true,  just, 
and  final  account  of  all  things  relating  to  their  said  business,  and  in  all  things 
truly  adjust  the  same;  and  all  the  stock,  as  well  as  the  gains  and  increase 
thereof,  which  shall  appear  to  be  remaining,  either  in  money,  goods,  wares, 
fixtures,  debts,  and  otherwise  shall  be  equitably  divided  between  them. 

IN  WITNESS  WHEREOF,  the  parties  hereto  have  hereunto  interchange- 
ably set  their  hands,  the  day  and  year  first  above  written. 

W.  C.  Harvey  (L.S.) 
H.  P.  Simmons  (L.S.) 


APPENDIX  381 

New  features  to  be  employed  in  the  accounting  for  June.  Owing  to  the 
rapidly  expanding  volume  of  the  business,  you  have  advised  the  partners 
to  make  use  of  certain  more  advanced  methods  in  keeping  the  records  of 
their  business.  They  give  you  a  free  hand  in  the  matter,  and  ask  you  to 
instal  any  new  features  that  you  consider  desirable.  You  make  the 
following  modification  in  the  system  as  at  present  existing: 

1.  Provision  for  further  analysis  in  the  sales  journal. 

2.  Inclusion  in  the  purchases  journal  of  all  purchases  on  account, 
whether  of  merchandise  or  not. 

3.  The  employment  of  a  petty  cash  fund,  to  be  kept  by  the  Imprest 
System. 

4.  The  use  of  the  cash  disbursements  journal  to  record  only  checks 
issued.    All  payments  in  currency  are  made  from  the  petty  cash  fund. 

5.  The  use  of  sales  and  credit  slips  as  a  basis  for  entries  and  also  in 
posting  to  customers'  accounts,  and- the  use  of  the  purchase  invoices  and 
other  vouchers  for  posting  t«Tcreditors'  accounts. 

6.  A  slight  modification  in  the  columns  used  in  the  cash  receipts  journal. 

1.  Additional  analysis  of  the  sales  journal.    It  is  desired  to  show  in  the 
sales  journal  not  only  the  total  of  the  sales  for  each  department,  but  also 
the  amount  of  cash  sales  for  each  department  and  of  credit  sales  for  each 
department.     Since,  as  will  be  explained  below,  posting  to  the  customers' 
accounts  will  now  be  done  directly  from  the  sales  tickets,  the  posting  from 
the  sales  journal  will  be  only  through  the  footings  of  columns.    The  col- 
umns required  will  therefore  be  as  follows:     (i)  Date,  (2)  Explanation, 
(3)  Accounts  Receivable,  Dr.,  (4)  Cash,  Dr.,  (5)  Charge  Sales  Hardware,  Cr., 
(6)  Charge  Sales  Furniture,  Cr.,  (7)  Cash  Sales  Hardware,  Cr.,  (8)  Cash 
Sales  Furniture,  Cr.,  (9)  Total  Hardware  Sales,  Cr., Total  Furniture  Sales,  Cr. 

This  arrangement  is  made  for  the  purpose  of  obtaining  more  analysis. 
As  regards  the  posting  to  the  ledger  accounts,  only  three  of  the  columns 
will  be  posted.  They  are  (a)  Accounts  Receivable,  Dr.,  (b)  Hardware  Sales, 
Cr.,  (c)  Furniture  Sales,  Cr.  The  debit  to  cash  will  be  made  in  the  cash 
receipts  journal. 

2.  Modification   of  purchases   journal.     All   purchases   on   account, 
whether  of  merchandise  or  not,  will  henceforth  be  recorded  in  the  purchases 
journal,  Accounts  Payable  being  debited  for  all  such  credit  purchases.    The 
columns  in  the  purchases  journal  will  be  as  follows:     (i)  Date,  (2)  Name, 
(3)  Address,  (4)  Terms.  (5)  Invoice  Number,  (6)  Folio,  (7)  Accounts  Payable, 
Cr.,  (8)  Hardware  Purchases,  Dr.,   (9)   Furniture  Purchases,  Dr.,   (10) 
Sundry  Accounts,  Dr.,  (a)  Name,  (b)  Folio,  (c)  Amount. 

The  posting  from  this  book  is  all  done  through  the  footings  of  columns, 
except  the  debits  to  such  ledger  accounts  as  are  not  provided  for  by  special 
columns,  and  which  are  entered  under  "Sundry  Accounts,  Dr." 


382  PRINCIPLES  OF  ACCOUNTING 

The  credits  to  individual  creditors'  accounts  will  be  posted  direct  from 
the  purchase  invoices,  and  for  purposes  of  this  exercise  this  posting  may  be 
taken  for  granted  and  ignored. 

3.  Use  of  the  imprest  system  for  petty  cash  fund.     All  cash  received 
by  the  business  is  to  be  deposited  and  to  be  disbursed  only  by  check.    This 
necessitates  some  device  by  which  small  currency  payments  may  be  made. 
This  matter  is  to  be  taken  care  of  by  means  of  a  petty  cash  fund.    This 
fund  will  be  established  by  drawing  a  check  for  the  amount  of  the  fund, 
entering  the  amount  of  such  check  in  the  cash  disbursements  journal  as  a 
debit  to  petty  cash.    This  check  will  be  cashed  by  the  custodian  of  petty 
cash,  who  will  disburse  the  money  as  required,  taking  a  voucher  for  each 
disbursement,  and  keeping  a  record  of  all  such  disbursements  and  the 
accounts  to  be  debited  in  a  subsidiary  journal  known  as  the  petty  cash 
book.    When  the  fund  needs  replenishment,  the  petty  cashier  will  present  to 
the  proper  authority  a  statement  of  the    amount    disbursed,    analyzed 
according  to  the  accounts  to  be  debited,  and  accompanied  by  all  the  vouch- 
ers for  such  disbursements,  and  a  check  will  be  drawn  for  the  amount 
necessary  to  bring  the  petty  cash  fund  up  to  its  original  figure.    The  entry 
in  the  cash  book  will  be  a  debit  to  each  of  the  accounts  shown  on  the  state- 
ment submitted  by  the  petty  cashier,  and  a  credit  to  cash.    Thus  in  this 
system  the  petty  cash  book  will  not  be  used  as  a  posting  medium,  and  the 
petty  cash  account  will  be  neither  debited  nor  credited  after  the  first  entry 
setting  up  the  debit  for  the  amount  at  which  this  account  is  to  be  maintained. 

The  student  is  expected  to  keep  a  record  of  petty  cash  expenditures  and 
to  make  the  record  for  the  replenishment  of  this  fund  whenever  it  runs  low. 

The  petty  cash  book  may  have  the  following  columns:  (i)  Date,  (2) 
Name  and  Explanation,  (3)  Receipts  Check  No.,  (4)  Disbursements 
Voucher  No.,  (5)  Petty  Cash,  Dr.,  (6)  Petty  Cash,  Cr.,  (7)  Office 
Expense,  Dr.,  (8)  Delivery  Expense,  Dr.,  (9)  Other  Selling  Expense,  Dr., 
(10)  Sundry  Accounts,  Dr.,  (a)  Name,  (b)  Amount. 

4.  The  cash  disbursements  journal.    The  form  of  cash  disbursements 
journal  used  in  this  exercise  is  the  same  as  the  one  used  in  Exercise  33, 
and  in  posting  from  this  book  the  same  procedure  will  be  followed  as  in  that 
exercise. 

5.  The  use  of  sales  and  credit  slips.    As  stated  above,  in  this  system 
neither  charge  sales  nor  cash  sales  will  be  entered  by  individual  transactions, 
but  will  be  entered  at  the  close  of  each  day's  business  as  totals,  the  amounts 
being  arrived  at  through  the  sorting  and  adding  up  of  the  sales  tickets. 
These  tickets  will  be  sorted  and  entered  on  the  basis  indicated  above  in  the 
discussion  of  the  analysis  of  sales.    The  total  debit  to  cash  from  cash  sales 
will  also  be  entered  in  the  cash  book  each  day.    The  posting  to  the  custo- 
mers' accounts  will  be  made  from  the  sales  tickets  themselves. 


APPENDIX  383 

Similarly,  all  credits  to  customers  will  be  entered  on  the  books  of 
original  entry  at  the  close  of  the  day's  business  by  means  of  a  summary 
of  the  day's  credit  slips,  while  the  posting  to  the  credit  of  individual  cus- 
tomers will  be  made  directly  from  the  credit  slips  themselves.  Thus  the 
total  credits  to  customers  for  collections  made  will  be  entered  in  the  cash 
book,  while  credits  for  returns  will  be  summarized  in  the  sales  returns  and 
allowances  journal. 

It  will  be  left  to  the  student  to  design  a  form  of  sales  returns  and  allow- 
ances journal  that  will  show  the  same  analysis  of  sales  returns  and  allowances 
that  is  shown  for  sales  in  the  sales  journal.  The  only  accounts  to  be  posted 
from  this  journal  are:  (i)  Accounts  Receivable,  (2)  Hardware  Sales  Returns 
and  Allowances,  and  (3)  Furniture  Sales  and  Allowances.  However,  the 
management  desires  to  have  the  same  analysis  made  in  the  book  of  original 
entry  that  is  made  of  sales  in  the  sales  journal. 

The  form  of  purchase  returns  and  allowances  journal  which  was  used 
last  month  will  serve  equally  well  for  this  month. 

6.  Form  of  cash  receipts  journal.  It  has  been  agreed  upon  that  dis- 
counts will  be  granted  the  purchasers  of  certain  classes  of  furniture  for 
payment  within  a  specified  number  of  days,  and  provision  therefore  must 
be  made  in  the  cash  receipts  journal  for  cash  discount  on  sales.  In  addition 
to  this  change  in  its  arrangement,  certain  other  slight  changes  are  thought 
desirable,  so  that  the  new  form  of  this  book  shows  the  following  columns: 
(i)  Date,  (2)  Account  Credited,  (3)  Explanation,  (4)  Folio,  (5)  Sundry  Ac- 
counts, Cr.,  (6)  Notes  Receivable,  Cr.,  (7)  Cash  Sales,  (8)  Accounts  Receiv- 
able, Cr.,  (9)  Cash  Discount  on  Sales,  Dr.,  (10)  Interest,  Dr.,  (n)  Cash,  Dr. 

The  method  of  posting  from  this  book  is  the  same  as  that  employed 
in  posting  the  form  used  last  month,  except  that  the  credits  to  customers 
are  no  longer  posted  from  the  cash  book,  but  directly  from  the  credit  slips. 

The  student  will  not  be  required  to  keep  a  customers'  ledger  in  con- 
nection with  this  exercise,  and  will  not  be  given  the  information  which  would 
enable  him  to  do  so.  The  creditors'  ledger  may  also  be  omitted  from  the 
exercise,  though  the  student  may  find  it  necessary  for  his  own  use  to  keep 
some  memoranda  concerning  the  amounts  due  to  individual  creditors. 
Only  the  summaries  of  sales  and  collections  and  other  credits  to  customers 
will  be  furnished  in  this  exercise.  « 

TRANSACTIONS  FOR  JUNE 

June  i  (Saturday) 

W.  C.  Harvey  deposits  a  check  for  $5,000.00  to  the  credit  of  the  new 
firm  of  Harvey  and  Simmons.  Simmons  makes  his  contribution  to  the  part- 
nership capital,  as  follows:  (a)  $3,000.00  in  American  Telephone  and  Tele- 
graph 6  per  cent  gold  bonds,  valued  at  par  plus  accrued  interest  (from  April  i) ; 


384  PRINCIPLES  OF  ACCOUNTING 

(6)  $4,000 .  oo  in  Swift  and  Company's  two-year  6  per  cent  gold  notes,  at  par, 
plus  accrued  interest  since  April  i ;  (c)  The  remaining  part  of  his  $i  5,000 .  oo 
investment  is  in  the  form  of  a  certified  check  on  the  Corn  Exchange  Bank. 
Charge  sales :  hardware,  $95 .  oo ;  furniture,  $75.  oo.  Cash  sales :  hardware , 
$63.00;  furniture,  $40.00.  Received  from  customers  on  account,  $145.00. 
Paid  pay-roll  as  follows:  bookkeeper,  $25.00,  one  sales  clerk  at  $30.00, 
and  one  at  $25.00,  a  driver  at  $25.00,  and  a  boy  for  general  work,  $18.00. 

June  j 

Paid  H.  Flanagan  rent  of  store  for  May,  $125.00.  Drew  a  check  for 
$50.00  to  set  up  a  petty  cash  fund.  Received  invoice  from  American 
Furniture  Company,  Milwaukee,  for  furniture,  $1,200.00,  2/10/60.  Paid 
freight  on  this  shipment,  $60.00.  Collections  on  account,  $105.00. 
Charge  sales:  hardware,  $78.00;  furniture, $110.00.  Cash  sales:  hardware, 
$65.00;  furniture,  $25.00.  Petty  cash  disbursements:  mending  office 
chair,  $3.00;  new  ribbon  for  typewriter,  $i .25. 

June  4 

Received  invoice  of  hardware  from  Simmons  Hardware  Company, 
$1,350.00,  2/10/30.  Received  invoice  from  Muskegon  Motors  Company 
for  new  motor  truck,  $950.00,  n/i5-  Sold  the  old  truck  for  $345.00. 
Paid  W.  D.  Allen  Company's  invoice  of  May  25,  less  discount.  Collections 
on  account,  $95.00.  Charge  sales:  hardware,  $125.00;  furniture,  $105.00. 
Cash  sales:  hardware,  $97.00;  furniture,  $40.00.  Petty  cash  disburse- 
ments: towels,  $4.50;  drinking  water,  $2.25;  carfare  for  deliveries,  $0.75. 

June  5 

Purchased,  from  Ackley  Brothers,  building  and  lot  at  6375  Kinzie 
Ave.,  for  $14,000.00.  (Building  $10,000.00.  lot  $4,000.00.)  Borrowed 
$8,000.00  from  Chicago  Realty  Loan  Company  on  our  note  for  five  years 
at  6  per  cent,  secured  by  a  first  mortgage  on  the  property.  Gave  Ackley 
Brothers  a  certified  check  for  $14,000 .  oo.  Collections  on  account,  $145 .  oo. 
We  have  adopted  the  policy  of  allowing  cash  discounts  as  an  inducement  to 
prompt  settlement  on  purchases  of  furniture  on  account.  Customers  are 
at  this  time  credited  with  $4.00  for  such  discounts,  making  the  total  credit 
$149.00.  Charge  sales:  hardware,  $107.50;  furniture,  $115.00.  Cash 
sales:  hardware,  $82.60;  furniture,  $45.00. 

June  6 

Returned  unsatisfactory  goods  to  American  Furniture  Company, 
being  credited  by  them  with  $145.00,  the  invoice  price,  and  also  for 
$6.00  freight  paid  by  us  on  the  goods.  The  following  bills  were  paid: 
Chicago  Telephone  Company,  rent  of  telephone  for  June,  $6.00,  and 


APPENDIX  385 

for  telegrams,  $12.70;  Commonwealth  Edison  Company,  light,  $7.42; 
Marquette  Garage,  for  care  of  car,  $35.50.  Customers  are  credited  for 
$135.00,  $131.50  of  this  being  for  cash  and  $3.50  for  cash  discounts. 
Paid  Western  Supply  Company's  invoice  of  May  23.  Petty  cash  disburse- 
ments: office  supplies,  $8.50.  Charge  sales:  hardware,  $78.50;  furniture, 
$110.00.  Cash  sales:  hardware,  $87.00;  furniture,  $35.00. 

June  7 

Charge  sales :  hardware,  $98 . 50 ;  furniture,  $ 1 7 5 .  oo.  Cash  sales :  hard- 
ware, $87 . 20;  furniture,  $22 . 50.  Credited  customers  for  a  total  of  $149 .00; 
$142.00  for  cash,  and  $7.00  for  cash  discount  on  sales.  Petty  cash  dis- 
bursements: mending  office  clock,  $3.00;  new  waste  baskets,  $2.50. 

June  8 

Paid  salaries  the  same  as  last  week.  Harvey  drew  $60 .  oo  for  personal 
use.  Simmons  drew  $50.00.  Received  invoice  of  hardware  from  Butler 
Brothers,  $500.00,  2/10/30.  Petty  cash:  stamps,  $20.00.  At  this  point 
the  petty  cash  fund  should  be  replenished.  A  voucher  will  be  made  out  for 
the  amount  expended  since  the  fund  is  established,  and  showing  the  dis- 
tribution to  the  accounts  to  be  debited.  A  check  will  be  drawn  for  that 
amount.  Charge  sales:  hardware,  $150.00;  furniture,  $112.50.  Cash 
sales:  hardware,  $85.00;  furniture,  $75.00. 

NOTE. — In  order  to  simplify  the  problem,  and  relieve  the  student  of  unneces- 
sary routine  work,  all  sales  and  collections  will  be  hereafter  stated  in  totals  at  the 
end  of  each  week. 

June  10 

Gave  check  to  Red  Cross  for  $40 .  oo.  Purchased  an  adding  machine 
from  the  Burroughs  Company,  $350.00,  giving  them  our  check  for  the 
amount.  James  Freeman  paid  his  note  of  April  10  for  $200.00,  with 
interest  at  6  per  cent.  Paid  Fred  Hanson  $125.00  for  certain  repairs  on 
our  newly  purchased  building,  these  repairs  being  necessary  before  the 
building  could  be  occupied.  Petty  cash:  express  on  goods  shipped  to  a 
customer,  $3.00. 

June  ii 

Received  invoice  from  Boutell  Furniture  Company,  $950.00,  2/10/30. 
Cash  refund  to  H.  A.  Howard,  a  customer,  for  furniture  returned,  $55.00. 
(Voucher  and  draw  check.)  Paid  the  Commercial  Lithographing  Com- 
pany $75.00  for  advertising  material.  Paid,  from  petty  cash  fund,  $2.25 
express  on  this  material. 

June  12 

Paid  balance  due  on  American  Furniture  Company's  invoice  of  June 
3,  less  discount  on  all  except  $145.00,  the  invoice  price  of  the  goods  re- 
turned. The  freight  allowance  counts  as  a  cash  payment.  Received  invoice 


386  PRINCIPLES  OF  ACCOUNTING 

from  W.  D.  Allen  Company,  $1,200.00,  2/10/30.  Paid  Pennsylvania 
Railroad  Company's  freight  bill  of  $49.50,  $32.00  in-freight  on  furniture, 
and  $17.50  being  for  in-freight  on  hardware.  Petty  cash:  stamps,  $10.00; 
brooms,  $3.00. 

June  13 

Paid  William  Burns,  contractor,  $750.00  for  work  done  on  our  newly 
purchased  building  to  adapt  it  to  our  purposes.  It  is  now  ready  for  occu- 
pancy. Received,  vouchered,  and  paid  invoice  from  Western  Safe  Company 
for  an  office  safe,  $150.00.  James  Thompson,  a  customer  who  owed  us 
$65.00  on  account,  has  disappeared,  leaving  a  number  of  unpaid  bills,  but 
no  address. 

June  14 

Paid  Simmons  Hardware  Company's  invoice  of  June  4,  less  discount. 
Received  invoice  of  furniture  from  Grand  Rapids  Chair  Company,  $1,100.00, 
1/10/60.  We  are  engaged  in  moving  to  the  new  building,  and  the  store  is 
closed  today  and  tomorrow  (Friday  and  Saturday). 

June  15 

Paid  weekly  pay-roll,  same  as  last  week.  Each  of  the  partners  drew 
$50.00.  Collections  for  the  week  were  as  follows:  cash  received,  $487 . 20; 
cash  discounts  taken  by  customers,  $16.40;  total  credit  to  customers, 
$503 . 60.  During  the  week  past  we  conducted  a  special  sale  preliminary 
to  moving.  Sales  for  the  four  days  were  as  follows:  charge  sales,  hardware, 
$724.00;  furniture,  $986.00.  Cash  sales:  hardware,  $662.00;  furniture, 
$752.00.  Paid  Hamilton  Transfer  Company  $150.00  for  moving  our 
stock  and  furniture.  It  is  estimated  that  the  work  done  by  our  own 
delivery  truck  in  moving  saved  the  firm  $30.00. 

June  17 

Received  notice  from  the  Woodlawn  Trust  and  Savings  Company, 
with  whom  we  discounted  C.  E.  Pierce's  thirty-day  note  for  $300.00,  with 
interest  at  6  per  cent,  that  this  note  has  been  dishonored  at  maturity, 
and  has  been  protested.  Sent  them  a  check  covering  the  face  of  the  note, 
the  interest,  and  a  protest  fee  of  $3.00.  We  notify  John  Fry,  whose 
name  appears  on  the  note  as  indorser.  We  were  successful  in  securing  a 
tenant  for  the  old  store  building,  and  received  his  check  for  $62 . 50,  the 
rent  for  the  second  half  of  June.  Paid  the  Smith  Advertising  Agency 
$250.00  to  cover  the  cost  of  advertising  for  last  week's  sale. 

June  18 

Received  John  Fry's  check  to  take  up  C.  E.  Pierce's  note,  including 
payment  of  interest  and  the  protest  fee.  Paid  Muskegon  Motors  Com- 
pany's invoice  of  June  4,  net  Received  invoice  from  Barrett-Christie 


APPENDIX  387 

Company,  hardware,  $850.00,  1/10/30.  Petty  cash:  advertising,  $6.50; 
stationery,  S8.  oo ;  stamps,  $10.00.  Paid  Butler  Brothers,  invoice  of  June  8, 
less  discount. 

June  ig 

Furniture  returned  to  us  for  credit,  $65.00.  Received  invoice  from 
Webster  Manufacturing  Company,  furniture,  $1,250.00,  2/10/60.  Paid 
in-freight  on  this  shipment,  $35.00.  Petty  cash:  new  desk  pads,  $1.00, 
supplies  for  trimming  window,  $3 . 50. 

June  20 

Received  invoice  from  Huron  Supply  Company  for  store  supplies; 
$150.00,  n/30.  Hardware  returned  for  cash,  $8.50.  This  was  paid  out 
of  the  petty  cash  fund.  Received  credit  memo  from  Grand  Rapids  Chair 
Company,  noting  a  credit  to  us  for  furniture  returned,  $200.00. 

June  21 

Paid  Boutell  P'urniture  Company's  invoice  of  June  ti,  less  discount. 
Bought  of  Chicago  Office  Supply  Company,  for  cash,  filing  cases,  $65.00. 
Received  invoice  from  Allegheny  Coal  Company  for  coal,  $525.00,  n/3O. 
This  represents  our  coal  supply  for  next  winter,  put  in  in  advance. 

June  22 

Paid  W.  D.  Allen  Company's  invoice  of  June  12,  less  discount.  Pay- 
roll for  the  week  vouchered  and  paid.  Each  of  the  partners  drew  $50.00. 
Charge  sales:  hardware,  $514.20;  furniture,  $705.50.  Cash  sales:  hard- 
ware, $428.60;  furniture,  $374.80.  Credits  to  customers:  cash,  $312.50; 
cash  discount  on  sales,  $13 . 50. 

June  24. 

Our  thirty- day  note  which  was  discounted  by  the  Woodlawn  Trust  and 
Savings  Company  on  April  25  was  not  paid  at  the  date  of  maturity,  May 
25,  but  was  renewed  at  ihat  time,  the  old  note  being  canceled,  and  a  new  one 
made  for  $500.00,  the  amount  of  the  old  note,  the  new  note  being  for 
thirty  days,  and  bearing  interest  at  6  per  cent.  Through  an  oversight,  no 
entry  was  made  on  the  books  at  that  time.  The  new  note,  which  falls 
due  today,  is  paid  with  interest.  William  Burns,  contractor,  has  com- 
pleted the  construction  of  a  garage  on  our  lot  back  of  the  store  building. 
We  give  him  our  check  for  $i  ,500 .  oo  to  cover  its  cost.  Paid  $60 .  oo  insur- 
ance premium  to  cover  insurance  on  our  new  garage  for  the  next  two 
years.  Paid  balance  due  on  Grand  Rapids  Chair  Company's  invoice  of 
June  14. 

June  25 

Received  invoice  from  Muskegon  Motors  Company  for  equipment  for 
the  garage,  $85  .00.  Sent  them  our  check  for  the  amount.  Henry  Peters, 


388  PRINCIPLES  OF  ACCOUNTING 

one  of  our  sales  clerks,  is  allowed  to  draw  $15 .00  in  advance  on  this  week's 
wages  to  enable  him  to  meet  the  annual  premium  on  his  insurance.  For 
convenience  this  is  paid  him  out  of  petty  cash. 

June  26 

Received  invoice  from  the  Standard  Oil  Company  for  hardware, 
$500.00,1/10/60.  Sales  returns,  for  credit:  hardware,  $9.75;  furniture, 
$25.00. 

June  27 

H.  F.  Lucas,  the  grocer  whose  store  adjoins  ours, -has  contracted  for 
the  use  of  a  part  of  our  garage  space,  at  the  rate  of  $25.00  a  month.  He 
pays  the  first  month's  rent  in  advance  to  bind  the  bargain  Andrew 
Anderson,  a  customer  who  owes  us  $47 . 50  on  account,  has  been  declared 
a  bankrupt,  his  property  has  been  sold  to  satisfy  labor  claims,  and  he  has 
left  the  city. 

June  28 

Paid  to  Illinois  Central  Railroad  Company:  in-freight,  hardware, 
$23.40;  in-freight,  furniture,  $42.75.  Paid  Barrett-Christie  Company's 
invoice  of  June  18.  Refunded  to  John  Hanson  $35.00  for  furniture  re- 
turned as  unsatisfactory.  Voucher  and  draw  a  check.  Petty  cash: 
stamps,  $10.00;  telegrams,  $2.30. 

June  29 

Paid  cartage  bill  for  the  month  to  Hamilton  Transfer  Company,  $58 . 90. 
Paid  salaries  same  as  last  week,  less  the  $15.00  advanced  to  Henry  Peters. 
Each  of  the  partners  drew  $50.00.  Charge  sales:  hardware.  $530.00; 
furniture,  $342.60.  Cash  sales:  hardware,  $615.75;  furniture,  $272.35. 
Credits  to  customers,  for  cash,  $215.20;  for  cash  discount,  $18.90. 

Inventories  of  merchandise  are  as  follows:  hardware,  $5,342.00; 
furniture,  $1,726.00. 

It  is  decided  to  charge  hardware  with  two-fifths  of  the  cost  of  cartage 
and  furniture  with  the  remainder.  It  is  estimated  that  one-tenth  of  the 
services  of  our  own  delivery  equipment  have  been  used  in  hauling  freight 
from  the  station. 

It  is  agreed  to  make  an  allowance  of  i  per  cent  on  charge  sales  for  the 
period  for  loss  from  uncollectable  accounts. 

Depreciation  on  the  various  fixed  assets  is  to  be  taken  as  follows: 
store  building,  12  per  cent  annually;  garage,  15  per  cent  annually;  store 
equipment.  18  per  cent  annually;  office  equipment,  18  per  cent  annually; 
motor  truck,  24  per  cent  annually. 

Figure  depreciation  for  the  month  on  the  total  of  each  fixed  asset  as 
shown  by  the  balance  of  the  account  at  the  end  of  the  month,  regardless 
of  what  time  during  the  month  the  purchase  was  made. 


APPENDIX  389 

Inventories  of  expense  items  are  as  follows:  prepaid  advertising, 
$10.00;  auto  supplies,  $17.00;  store  supplies,  $32.50;  office  supplies, 
$22.00. 

Advertising  payable  is  accrued,  $30 .  oo. 

Make  all  necessary  adjustments  for  interest  and  for  insurance  premiums 
used  and  unused. 

Credit  each  of  the  partners'  personal  accounts  with  his  stipulated 
salary.  It  is  estimated  that  Harvey  spends  three-fifths  of  his  time  in 
administrative  work,  and  two-fifths  in  selling.  Simmons  is  supposed  to 
spend  one-third  of  his  time  in  the  administrative  work,  and  two-thirds  in 
selling. 

Instructions.  Post  to  the  ledger  all  entries  for  the  month's  transactions, 
and  take  a  trial  balance  (preliminary  trial  balance).  Then,  with  the  aid 
of  the  data  given  above,  prepare 

1.  A  working  sheet 

2.  A  statement  of  profit  and  loss 

3.  A  balance  sheet 

When. this  is  done,  make  your  adjusting  entries  in  the  journal,  and  post 
them  to  the  ledger  accounts.  Then  draft  the  closing  entries  in  the  journal, 
fx)st,  and  rule  up  the  accounts  closed. 


INDEX 


Acceptance,  169,  207;  trade,  207. 

Account,  53-63;  adjusting,  101,  305; 
balance  of,  57;  classification  of,  335, 
346;  closing,  100,  326;  construction 
of,  56;  form,  56;  interpretation  of 
balance,  58;  numbering  of,  343; 
purpose  of,  53. 

Accounting:  for  trade  acceptances,  210; 
function  of,  2,  10;  information 
furnished  by,  3, 10;  process,  186, 191; 
relation  to  proprietorship,  13,  21; 
reports,  3,  18,  186;  terminology  of, 
29,  60. 

Accounts  with:  Accounts  Payable,  71, 
266;  Accounts  Receivable,  69,  254; 
Administrative  Expense,  86;  Buying 
Expenses,  83;  Cash,  67,  253;  Cash 
Discounts,  292,  302;  Creditors,  70, 
266;  Debtors,  68,  254;  Delivery  and. 
Drayage  Expense,  84;  Depreciation 
Reserves,  74,  75,  259;  Fixed  Assets, 
71,259;  Interest,  291,  302;  Merchan- 
dise, 81,  82,  288,  296;  Notes  Pay- 
able, 70,  267;  Notes  Receivable,  68, 
256;  Notes  Receivable  Discounted, 
257;  Notes  Receivable  Dishonored, 
259;  Operating  Expenses,  83,  295; 
Proprietorship,  76,  273,  279;  Pro- 
prietorship Reserves,  280;  Purchase 
Deductions,  297;  Sales  Deductions, 
290;  Selling  Expenses,  84. 

Accruals  and  deferred  items,  305; 
accrued  expenses,  308;  accrued  in- 
come, 305;  deferred  charges  to 
expense,  310;  deferred  credits  to 
income,  313. 

Adjusting  entries,  101,  152,  318,  328; 
Merchandise  Inventory,  102;  Need 
of,  101,  318. 

Administrative  Expenses  account,  86. 
Ad  vantages  of  controlling  accounts,  251; 
of  the  graphic  method,  376. 

Analysis  of  cash  disbursements,  227;  of 
cash  receipts,  223;  of  sales  by  depart- 
ment, 216;  of  surplus  account,  353. 

Analytical  statements,  352. 

Arrangements  of  accounts  in  ledger,  86. 

Assets,  17,  253-60. 


Bad  Debts,  Reserve  for,  255. 

Balance  of  an  account,  57,  325,  353. 

Balance  sheet,  25-33,  48,  263,  325,  350, 
353!  comparative,  353;  form,  26; 
function  of,  25;  heading,  31;  sub- 
titles, 31;  terminology,  29;  use  by 
manager,  48. 

Balancing  the  accounts,  1 14. 

Bank  statement,  182. 

Basis  of  business  management,  13. 

Bill  of  lading,  179. 

Bonds  Payable,  269. 

Books  of  original  entry,  118,  132,  147, 
188,  212,  223,  237;  Cash  book,  140, 
215,  223;  Journal,  118,  147;  Pur- 
chases journal,  135,  219;  Sales  jour- 
nal, 138,  214. 

Buildings  account,  262. 

Business  practice  and  procedure,  193, 
202;  handling  cash  disbursements, 
203;  handling  cash  receipts,  202; 
methods  of  handling  Notes  Receiv- 
able and  Payable,  206;  methods  of 
handling  Purchases,  193;  methods  of 
handling  Sales,  197;  petty  cash  funds, 
204;  shipping  or  delivering  merchan- 
dise, 199;  trade  acceptance,  207. 

Business  vouchers  and  forms,  159,  174, 
189;  classification,  160;  forms  used 
in  bank  transactions,  180;  merchan- 
dise invoice,  160;  miscellaneous 
forms,  176;  negotiable  instruments, 
162;  purpose,  159. 

Buying  Expense  account,  63. 

Capital  stock,  277. 

Cash  account,  67. 

Cash  book,  140,  223;  form,  141; 
illustrations,  141,  142,  226,  228,  229, 
244,  245;  ifnormation  shown  by, 
142;  posting,  143. 

Cash  Disbursements  journal,  228,  229, 
241,  245. 

Cash  Receipts  journal,  225,  226,  239, 
244. 

Cash,  recording  of,  223-28. 

Cash  Sales,  215. 


392 


PRINCIPLES  OF  ACCOUNTING 


Cashier's  check,  169. 

Charges  to  capital  versus  charges  to 

revenue,  260. 
Cheek,  184. 
Classification  of  accounts,  334-46;    of 

expenses,  44,  295;  of  income,  288;  of 

vouchers  and  forms,  160. 
Closing  an  account,  114,  115;   entries, 

iS3,  326. 

Comparative  balance  sheet,  353;  State- 
ment of  Profit  and  Loss,  358. 
Comparison  by  graphic  method :  Gross 

Sales  with  Advertising  Expense,  372; 

Gross  Sales  with  Cost  of  Goods  Sold; 

370;  Gross  Sales  with  Net  Profit, 374; 

Gross   Sales   with   Net   Sales,   370; 

Gross  Sales  with  Operating  Expenses, 

373- 
Construction  of  accounts,  60,  67,  81, 

253,  266,  273,  288,  295. 
Controlling  accounts,  237-50. 
Conventional  financial  reports,  349. 
Cost  of  Goods  Sold,  43,  296,  298. 
Creditors,  8,  28,  70. 
Current    accounts,     ruling    of,     115; 

entries,  149;  liabilities,  266. 

Debits  and  Credits:  determination  of, 
63;  equality  of,  63;  relation  to  the 
account,  60. 

Debtors,  accounts  with,  68. 

Debts  owed  to  creditors,  28;  by 
customers,  27. 

Deductions-  from  Income,  301;  from 
Purchases,  221,  297:  from  Sales,  217, 
290. 

Deferred  Charges  to  Expense,  310; 
Credits  to  Income,  313. 

Delivery  Equipment,  75, 105;  Expense, 
84. 

Departmental  analysis:  in  Purchases 
journal,  220;  of  Purchase  Deduc- 
tions, 221;  of  Sales,  216;  of  Sales 
Deductions,  217. 

Deposit  ticket,  181. 

Depreciation:  balance  sheet,  31,  73: 
entries  necessary  for,  105,  321; 
method  of  showing  accounts,  74,  75, 
262-64, 3°i !  necessity  for  showing,  30. 

Dewey  decimal  system  for  numbering 
accounts,  343. 

Discount  on  Stock,  278. 


Discounts  for  Cash  on  Purchases,  292; 
on  Sales,  302. 

Diversified  reports  required  by  manage- 
ment, 364. 

Drafts:  accepted,  169;  bank,  166; 
commercial,  166. 

Effect  of  special  journals  on  general 
journal,  147. 

Entries,  journal:  adjusting,  152,  318; 
closing,  153,  326;  current,  149; 
opening,  147;  post-closing,  328. 

Equality  of  debits  and  credits  to  ac- 
counts, 63. 

Exhibits,  350. 

Expense  accounts:  accrued,  308;  esti- 
mated, 300;  kinds  of,  83,  288; 
prepaid,  310. 

Express  money  orders,  170. 

Financial  reports,  349;  analysis  of 
surplus,  353;  analytical  statements, 
352;  comparative  balance  sheet,  353; 
Comparative  Statement  of  Profit  and 

•  Loss,  358;  conventional  reports,  349; 
exhibits,  350;  nature  and  purpose, 
349;  schedules,  351;  Statement  of 
Receipts  and  Disbursements,  361. 

Fixed  Assets,  accounts  with,  259. 

Fixed  Liabilities,  accounts  with,  268. 

Form:  account,  56;  balance  sheet,  26; 
Cash  book,  141,  225,  228;  Journal, 
122;  merchandise  invoice,  160;  pro- 
prietorship, 18-20;  Purchase  journal, 
135,  220;  .Sales  journal,  137,  214; 
Statement  of  Profit  and  Loss,  41. 

Forms  used  in  transactions  in  the  bank, 
179;  bank  statement,  182;  check, 
184;  deposit  ticket,  181;  passbook, 
182;  signature  card,  182. 

Freight,  Express,  and  Cartage,  298. 

Function  of  balance  sheet,  25. 

Fundamental  classification  of  accounts, 
335;  property  accounts,  336;  pro- 
prietorship accounts,  337;  revenue 
accounts,  338. 

Fundamentals  of  accounting  same  for 
all  classes,  i. 

Graphical  method  of  presenting  ac- 
counting facts,  364;  advantages,  376; 
illustrations,  366-76;  limitations, 
376;  use,  364. 

Gross  profit  on  sales,  10^. 


INDEX 


393 


Handling  of  Notes  Receivable  and 
Payable,  206;  of  Purchases,  193'; 
of  Sales,  197. 

Heading  of  balance  sheet,  31;  of 
Statement  of  Profit  and  Loss,  46. 

Illustrations  (see  List  of  Illustrations, 
page  xxi). 

Importance  of  accounting  process,  191. 

Imprest  system  for  petty  cash,  204. 

Income  accounts,  288;  kinds.  288;  oper- 
ating, 288;  non-operating,  291. 

Indorsement  of  negotiable  instruments, 
174-76. 

Insurance,  311. 

Interest,  291,  302,  313-15;  on  Notes 
Payable,  302;  on  Notes  Receivable, 
291;  Unearned,  313. 

Interpretation  of  the  account  balance, 
58. 

Inventory  account,  82,  102. 

Investment,  14. 

Investors,  7. 

Invoice,  160-6?. 

Journal:  defined,  121;  modern  use, 
H7-53;  special  forms,  132-43,  212- 
28;  standard  forms,  122;  subdi- 
visions of,  212. 

Kinds  of  expense  accounts,  295;  of 
income  accounts,  288;  of  negotiable 
Instruments,  166. 

Lack  of  uniformity  in  classification  of 

accounts,  346. 
Ledger,  60;    appearance  after  closing, 

113;  arrangement  of  accounts  in,  86; 

content,  60;    need  for  record  other 

than,  118. 

Liabilities,  70,  266-71. 

Limitations  of  graphic  method,  376. 

Long-term  notes,  271. 

Management:  accounting  an  aid  to,  6; 
basis  of,  13;  diversified  reports 
required,  364. 

Means    of    classifying    business    data 

needed,  53. 
Merchandise  creditors,  28;    inventory, 

82,  102;    invoice,   160;    shipping  or 

delivery  of.  IQQ. 


Method:  graphic,  364-79;  of  handling 
Notes  Receivable  and  Payable,  206; 
of  handling  purchases,  193;  of 
handling  Sales,  197;  of  taking  a  trial 
balance,  92;  of  determining  valua- 
tion of  certain  assets,  30. 

Miscellaneous  business  forms,  176. 

Money  orders,  170. 

Mortgages  Payable,  269. 

Nature  of  books  of  original  entry,  120; 
of  Cash  book,  142;  of  reports 
affected  by  functional  organization, 
6;  and  purpose  of  financial  reports, 
349- 

Need  of  adjusting  entries,  101,  318; 
for  record  other  than  ledger,  118; 
for  special  books  of  record,  132. 

Negotiable  instruments,  162;  cashier's 
checks,  169;  drafts,  1 66;  express  and 
postal  money  orders,  170;  indorse- 
ment, 174;  kinds,  1 66;  requisites  of , 
165. 

Net  operating  profit,  in. 

Non-operating  income  accounts,  291. 

Note  accounts,  ruling  of,  115. 

Notes:  long-term,  271;  Payable,  70, 
206,  267;  Receivable,  68,  206,  256; 
Receivable  Discounted,  257;  Receiv- 
able Dishonored,  259. 

Numbering  of  accounts,  344. 

Object  of  business  operations  to  increase 
proprietorship,  16. 

Office  Furniture,  73,  105. 

Opening  entries,  147. 

Operating  expenses,  83,  295-99;  in- 
come, 288;  profit,  in;  and  non- 
operating  expenses,  44. 

Other  methods  of  graphic  presentation, 
374- 

Owners,  reports  required  by,  7. 

Partnership,  19,  275. 

Partner's  capital  account,  273;  drawing 
account,  275. 

Pass  book,  182. 

Percentages :  use  in  Comparative  State- 
ment of  Profit  and  Loss,  358;  use  to 
express  comparisons,  369. 

Petty  cash  funds.  204. 


394 


PRINCIPLES  OF  ACCOUNTING 


Postal  money  order,  1 70. 

Post-closing  entries,  328;  trial  balance, 
329. 

Posting:  from  the  Cash  book,  143,  240; 
from  the  Journal,  126;  from  the 
Purchases  Journal,  137;  from  the 
Sales  journal,  140. 

Prepaid  Insurance  account,  312. 

Profit  and  Loss  account,  in. 

Property  accounts,  336. 

Proprietorship,  15:  accounts,  76,  273- 
80;  classification,  338;  in  the  cor- 
poration, 277-80;  in  the  partnership, 
275;  in  the  single  proprietorship,  76, 
273,338:  defined,  17;  forms,  18-21. 

Purchase  deductions,  221,  297;  Dis- 
count account,  292;  invoice,  196; 
other  than  merchandise,  220;  order, 
195;  requisition,  194;  Purchases 
account,  81,  296;  Returns  and 
Allowances  journal,  221. 

Purpose  of  books  of  original  entry,  212; 
of  closing  entries,  109;  of  financial 
reports,  340;  served  by  the  accounts, 
334;  of  the  trial  balance,  92;  of  the 
voucher,  159. 

Receipt,  178. 

Recording  cash  disbursements,  228; 
cash  receipts,  225;  cash  sales,  215; 
purchases,  219;  retail  sales,  217; 
sales,  214. 

Reports:  accountant's  task  to  prepare, 
10;  accounting,  186;  affected  by 
functional  organization,  6;  may  be 
of  different  types,  3;  required  by 
creditors,  8;  required  by  owners 
and  investors,  7;  useful  to  various 
parties,  3. 

Requisites  of  negotiable  instruments, 
165. 

Requisition,  purchases,  194. 

Reserve  for  Bad  Debts,  255;  for 
Depreciation  on  Delivery  Equip 
ment,  75;  on  Office  Furniture,  74. 

Reserves,  proprietorship,  280. 

Revenue  accounts,  340. 

Ruling  of  current  accounts,  115. 

Sales,  43;  account,  82,  288;  analysis 
by  departments,  216;  deductions, 
217;  discounts  on,  302;  for  cash,  215; 


gross  profit  on,    109;    invoice,  190; 
•  journal,   138.   214;    journal  posting, 

140,  239;   methods  of  handling,  197; 

order,   197;    recording,   214;     retail, 

217;  returns  and  allowances  journal, 

218;   ticket,  163. 
Schedules,  35. 

Selling  Expense  account,  84,  299. 
Shipping  or  delivery  of  merchandise, 

199. 

Signature  card,  182. 
Source  of  ledger  entries,  118. 
Special   columns   in  books  of  original 

entry,  213,  237;  forms  of  the  journal, 

132,  212. 

Statement  of  account,  177 

Statement  of  Profit  and  Loss,  39,  32?; 
a  type  of  accounting  report,  48; 
comparative  form,  358;  form,  41; 
heading  or  title,  46;  needed  to  sup- 
plement balance  sheet,  39. 

Statement  of  Receipts  and  Disburse- 
ments, 361 

Statistical  method  in  accounting,  364. 
Subdivisions  of  journal,  212. 
Subtitles  of  balance  sheet,  31. 
Surplus  account,  279;  analysis  of,  353. 

Title  of  balance  sheet,  31:  of  Statement 

of  Profit  and  Loss,  45. 
Trade  acceptance,  207:  accounting  for, 

210. 
Trial  balance,  02;  method  of  taking,  92; 

post  closing,  329;    purpose,  92;    use 

as  a  report,  97. 
Types  of  accruals  and  deferred  items, 

305- 

Use  of  controlling  accounts,  242;  of 
special  columns,  213,  237;  of  statisti- 
cal method,  364;  of  terms  debit  and 
credit  in  relation  to  accounts,  60;  of 
trade  acceptance,  207. 

Usefulness  of  reports,  3. 

Valuation  accounts,  262,  263;  of  assets, 

3°,  254,  259. 
Vouchers,   159-84,   189;    classification, 

1 60;     purpose.     159;      relation     to 

accounting  process,  189. 

Working  sheet,  319. 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 

Los  Angeles 
This  book  is  DUE  on  the  last  date  stamped  below. 


JUL  3  1    1968 


Form  L9-32m-8,'57(.C8680s4)444 


6-1 


A     000322100 


«  ERN    BRANCH 

UN1V          ~V  ,  ,  CALIFORNIA 
3RARY 

L  ,GELES.  CALIF. 


